It's more than money

Opportunity Arriving Daily

2010-08-18T15:58:00.000-04:00

Sir John Templeton, Jonathan Smith, and William H. Barnhardt
Douglas Airport, Charlotte, NC sometime in August 1987
Photographer: J. David Barnhardt

During the 1980’s, I had the unalloyed privilege of managing some money for the late Sir John Templeton. Every now and again, I pause to consider that one of the world’s wisest investors mentored me, with his money and on his dime, and I am profoundly grateful.

His wisdom was vast, his insights were unconventional, and his generosity knew no bounds. Sir John was always a learner and never a knower. Learners keep flexible and open-minded; knowers are brittle. When naysayers challenged his view that life continually offered wonderful opportunities, he countered that opportunities were not all gone, what was missing was preparation. Wisdom like this takes years to sink in. Some do not ever get it.

This summer, a Chattanooga friend who knows Lauren Templeton, the founder of the investment firm bearing her name, told her that years ago I managed some money for Sir John. Lauren is the wife of Scott Phillips, a principal and portfolio manager at Lauren Templeton Capital Management, LLC and the great-niece of Sir John Templeton. We three connected and talked for over an hour, a joy that reminded me of many conversations with John Templeton himself. This week, I shared my recollection of Sir John’s views on opportunity and preparation with Scott. He reminded me that Sir John once said that the very reason he went to the trouble to save half of his income was so he would have the necessary funds ready to take advantage of future opportunities, since opportunities often appear when least expected. This Scott knows, as is evidenced throughout his latest book, Buying at the Point of Maximum Pessimism, Six Value Trends From China to Oil to Agriculture.

At Jonathan Smith & Co., Investment Counsel, we recognize volatility in financial markets is high and is likely to remain high. Our experience is that volatility can be unbearably unsettling to investors, leading them to sell good companies for wrong reasons. Volatility can also paralyze investors, preventing them from taking steps that historically, over the long haul, have been in their best interests: buying quality investments whose margins of safety are high. Investors are not the only ones who must manage volatility successfully if they want to survive; read how hard pilots have it when their outlooks are horribly pessimistic:

"There's an exercise that some pilots go through late in their flight training. The student pilot gets the plane airborne, at cruising altitude. Then the instructor places a loose-fitting, thick-woven sack over the student's head, so the student can see nothing. The instructor takes the controls and starts stunt-piloting. He loops the loop. He pushes the plane, Turkish-headache-style, skyward, then flips belly-up and swoops earthward. He rollicks and spirals, careens and nosedives, tailspins and wing-tilts. He gets the student utter discombobulated. Then he puts the plane in a suicide dive, plucks the bag off the student's head, and hands him the controls. His job: to get the plane back under control." (Mark Buchanan, The Rest of God, Restoring your Soul by Restoring Sabbath, page 37)

Getting investors’ “financial planes” back under control is the JSCO Way, yet so many investors are still utterly discombobulated, their planes in suicide dives. If the instructor has plucked the bag off your head, handed you the controls, and if it feels like you are approaching earth at 17,333 feet per second, give us a call, we can put your nosedive on hold for as long as it takes to have a conversation about getting your financial plane back under control. And if you do not want to, we will hand you back the controls while our parachutes still have time to open.

Looking at Investing Through the Eyes of a Landlord

2010-07-23T16:45:00.003-04:00

It seemed like a really great idea at first. And it actually was, but somewhere along the way, it turned bad, really bad. I’m not quite sure when, but it was either before or after a tenant started breeding Pit Bulls in the back bedroom . . . well, now that I say that, it was probably before. The story starts a good six years before the Pit Bulls. I was just finishing my freshman year in college. Four friends and I were looking for an apartment that would rent to five college kids, but no one would go above four (that should have been my first hint). So I hatched an idea and floated it past Jonathan (side note: I quit referring to him as “Dad” after my first day of work here). I proposed that we use my first-time homebuyer status to get a cheap loan, then buy a four bedroom condo, cover our mortgage with the rent from my four roommates, and on graduation day we’d easily sell it and voila, three years of rent free living. I was, as we say, very bullish.

It worked well for the first three years. In addition to the rent working out as planned, I happened to meet my wife, Millie, who was living in the building next door (I later learned she had made the same proposal to her Mom and they owned her condo also – the serendipity!) Three years later, my roommates became my groomsmen when Millie and I married a month after graduation and, even though we couldn’t sell the condo right away, we found some decent tenants to tide us over for “just a few months.”

That first batch of tenants sent their checks in on time and didn’t scuff up the walls too badly. But as we continued to rent it out while looking for a buyer, we discovered each group of tenants brought new troubles. Our costs went up: carpets had to be cleaned after each tenant, washers broke, and rooms were painted black. And our emotional expense went up as well: lost sleep over dealing with missed rents and worry over our exit price. All the while our potential liabilities piled up: the smoke detectors went unattended, the 3rd floor porch railing was removed for an impromptu golf driving range, and of course the aforementioned Pit Bull husbandry. Thankfully, the world is full of enterprising young men with four friends who want to live together – we were lucky enough to sell our place to one such “investor” well before the housing market collapsed.

The Tenants or “You’re Going to Let Who Stay in Our Hotel?!?”

Arabic Numbers: Where the 4’s look like backwards 3’s

We have a good friend who refers to monthly statements and the flashing data on CNBC as “Arabic Numbers” because they have no real significance without someone willing to interpret and apply them to a specific investor’s situation. One of the “interpretation” tools we use is to view our investment portfolio through the eyes of a Landlord.

As far as we’re concerned, every investor, from the parents saving for college to Warren Buffett himself, is the Owner and de facto Landlord of a 100 room hotel. Each room represents 1% of their portfolio and each Landlord has the choice to rent out each room to a variety of tenants with various quirks. We’d like to introduce the tenants and shed light on how this framework helps us see and navigate the current environment.

Bonds: We have a wide spectrum, but let’s start with our average Bond. We’ll call him James Bond and he agrees to pay us a stated rent and even shows us his estimated payment schedule. In addition, if we let him stay and don’t evict him before the term of his lease is up (if we don’t sell our Bond before maturity), then James promises to leave the room in the same condition he found it. At one end of the spectrum, we have our safest Bond, a US Treasury, who we’ll call T. Bill Bond. Bill has never missed a payment in over 200 years and is pretty well regarded globally. He won’t pay us as much rent as James, but we usually sleep well at night with him in our rooms. At the other end is the riskier High Yield Bonds, we’ll call Barry Bond. Barry has high hopes and offers big promises. He owes a lot of money to his lenders and doesn’t have the best track record of paying his rent. The only reason we let him set foot in one of our rooms is because he promises to give us a large rent check . . . and, like all Bonds, we have a legal contract we can enforce in case he backs out.

Stocks: We have a very curious relationship with our Stock tenants. It really couldn’t look more different from Bonds. In most cases, we allow Stocks to stay with no promise or expectation of a monthly rent. Why? Well, our proposal to Stocks goes like this: we let them stay rent free with no lease agreement in hopes that when we kick them out (sell them), they’ll pay us all their “back rent” in one lump sum payment. It sounds pretty preposterous, but history shows that over long stretches of time, Stocks pay a pretty decent rent. It’s like they are so thankful for a place to “live” while they sell their iThings, Microthings, and Googlethings that they are happy to share in the profits when they move out.

Of course, there are plenty of times when Stocks don’t pay rent when they move out. The best outcome in that situation is that they leave the hotel room the way they found it and we can just rent it out again to whoever we choose (we have no loss on our position). The worst outcome is when we rent a room (or worse, multiple rooms) to someone like those Lehman Brothers or someone who will go unnamed but whose initials are AIG. They not only stiffed their Landlords, but they stole bathrobes, set the drapes on fire, and got the hotel room permanently condemned.

Dividend Stocks: A subset of the Stock tenants is the Dividend Paying Stocks. These Dividenders say they’ll pay a monthly rent, but they give no legal promise. In fact, all that the Landlord has to go on is the Dividender’s history, their word, and their deeds. This can leave the unsuspecting Landlord open for much disappointment. We’ve seen it plenty of times (and even been tricked ourselves); some Dividenders say they’ll pay rent but end up over-promising and under-delivering. Inevitably they don’t pay the advertised rent, or even a fraction of it. When the Landlord gets fed up with their broken promises and kicks them out, they find a hotel room that looks like it was inhabited by an ‘80’s Rock Band. This is why our “screening” process for these Dividenders goes far beyond looking at last month’s rent check. As we’ve mentioned in prior commentaries, we look at their rental history, “job security”, other financial obligations, and, most importantly, their ability and willingness to increase their rent payments.

Third floor Driving Range
Note: Do Not Try This At Home

Gold: Just when it seems that we couldn’t get much different than the above mentioned cast of characters, we meet the most unusual fellow of all: Gold. On the surface, he seems like the last person we’d want to rent to: he has no job, no real prospects for employment, he promises no monthly rent and his only redeeming attribute is that he’s a snazzy dresser . . . and, or course, he’s always been a hit with the ladies. The only way that I, as a Landlord, can make a profit by renting to Gold is by pawning him off on the next Landlord who pays me a premium. Today, Landlords are clamoring for Gold – they’re paying close to historical highs to prior Landlords just for the opportunity to let him in their rooms. This isn’t to say he’s a bad guy. He has a long history of being the go-to tenant in times of uncertainty and fear – it’s just important to know what we’re getting into. Warren Buffett agrees when he says about Gold, “It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

Cash: After all these instances of skipping rent and trashing rooms (it feels like I’m watching Tom Hanks in The Money Pit ), one doesn’t have to explain the appeal of Cash. In effect, owning Cash is the equivalent of putting a “No Vacancy” sign on any number of doors. While we won’t collect any rent, we’re guaranteed to have our room in the condition we left it – chocolates still on the pillows and the toilet-paper roll still folded into a point. Of course, an empty room provides little comfort when costs inflate.

The Landscape or “Where’s the Rent Coming From This Month?”

That’s a lot of words spent on setting the stage, so we’ll get right to the point, which is what we see happening in the markets. Recession, Inflation, Deflation, and Interest Rates seem to be on everyone’s mind, so we’ll spend the rest of our time there.

The Money Pit tagline is eerily appropriate:
“For everyone who's ever been deeply in
Love or deeply in Debt”

Recession impacts our Stock tenants just like it would any real-life tenant. If Joe Stock’s income is squeezed, he has less money to spend on rent. Same goes for the Dividenders, if they aren’t committed to sending their monthly rent check, they will either reduce or eliminate it all together. We think the probability of another recession (or just continuing the one we may not have ever really exited) is about 50/50. Add in the possibility of large tax increases in 2011 which bring a “negative multiplier” effect (it hurts growth 2-3x more than it helps tax revenues) and a recession gets more certain. The key to renting to Stocks when the shadow of recession is in view, is to only offer rooms to those tenants with secure jobs and predictable salaries, and to have realistically low expectations for “exit rent” that would still make it worthwhile to the Landlord.

Inflation is the silent killer of the hotel business; most evidently in our Cash and Bond rooms. We see it in our hotel’s rising prices of utility bills, staff health insurance and pool maintenance. While our Stocks have jobs that will likely pay them more in times of inflation (thus passing that along to the Landlord) our Bonds have contracted a set amount of monthly rent and our Cash is paying us nothing. While we think it’s a near certainty that we’ll have some period of rapid inflation in the US, the question is “When?” We, for one, do not want to be holding a massive amount of Bonds when inflation returns, forcing interest rates to shoot up, and we’re stuck with an undesirable tenant.

Deflation, a decline in prices, is the flipside of inflation. It’s easy enough to see that this has the opposite effects of inflation and, from where we sit, this seems to be a likely short-term scenario. Even though the Fed is printing money and injecting stimulus, if banks and consumers are holding on to funds at an even faster clip, the end result is that money is being taken out of the economy, prices quit going up, and interest rates go lower. In our Portfolio Hotel, deflation will favor Bond holdings (because we’re happy to collect their now relatively high monthly rents) and favor the Quality, Dividend-Paying Stocks over the Non-Paying Stocks (again, due to the rent coming in). If and when we see deflation, we don’t think it will be a long period and we’re not ones to want to stake long-term assets on a short-term event. So, while we have adequate Bond exposure, we’ve stopped short of overweighting this short-term scenario. Rather, we’re choosing to “bet” on deflation by being more certain that our clients have adequate personal reserves and are paying off any expensive debts. In other words, we’re less inclined to rent out rooms that we might want to live in over the next couple years.

Mr. Buffett reminds us, “Be fearful when others are greedy and be greedy only when others are fearful.” We’d rephrase that for our hotel analogy to say, “Rent out your rooms when other Landlords lock their doors, and light up your ‘No Vacancy’ sign when others swing the doors open wide.” While we expect overall returns going forward to be lower than historical averages, we are by no means disappointed with the tenants we’ve opened our doors to. Rest assured that we, as the Landlords of our clients’ Hotels, have filled our rooms with a mix of renters that we fully expect to help our clients reach their goals regardless of the larger macroeconomic outcome.

Justin Smith, CFA®, CFP®
Financial Advisor

What we learned from the Doctor

2010-07-20T09:00:00.004-04:00

Justin here. I read a great article in the WSJ this morning (here) about a movement to get more doctors to give their notes to their patients.

We have a client couple where the wife has battled through a fight with breast cancer. The husband said one of the best things about their doctor was that he would photocopy his notes after they talked and give them a copy before they left the doctor's office. He said the transparency meant a lot to him and his wife.

We've always given some sort of recap after meetings, but it usually only involves the action points coming out ("Jim and Jane need to revisit wills.") but we didn't always send our clients the full meeting notes ("Jim and Jane need to revisit will because Jane is nervous about Jim providing too much money to his grown kids from his previous marriage.")

So, after our client told us how important it was to them in their cancer fight, we started being more intentional. While we don't copy our handwritten notes (they wouldn't be much help) we've started sending clients full recaps of the meetings. Sure, it takes some time, but we find that it adds some accountability (for us and the clients) and, like with our clients and their doctor, improves transparency. We see it as standard operating procedure.

Unintended Consequences in Aid to Haitian Woman

2010-07-02T11:02:00.003-04:00

In February, NPR played a story about woman in Haiti, Yvrose Jean Baptiste, who basically loses her business in the earthquake. She desn’t know how she’ll go on, owes the bank $100 while selling chicken necks at the market for pennies. Then in a genuine act of kindness and humanity, NPR listeners flood her bank account with money . . . $3,860 (more than a few years’ wages).

Today, they followed up with her. She withdrew the money, put her four kids in school, bought a stand at the market and inventory. It dramatically changes her life for the better - you nearly expect Hollywood to start buying the movie rights . . . until her husband leaves her. He doesn’t know how to handle the shift in power in the marriage. Today she says she's happy but she doesn’t sleep well at night (still under a tent) fearing she will be robbed because she doesn’t have a husband to protect her.

Three lessons:

We all have the ability to radically change someone's life through mere generosity, but
Bailouts rarely work like we expect them to and
Money rarely solves problems we’ve yet to encounter.

Full story here: http://www.npr.org/blogs/money/2010/07/01/128245622/yvrose

Today's headlines are rarely the same as what history's judgement is going to be

2010-06-10T18:56:00.001-04:00

Photo courtesy FaceBook

Jonathan here: Went to Stamey's for a late lunch, all by myself. I was really looking forward to three four things: a world class hot dog all the way (that's mustard, chili, onions, and Cole slaw for you northerners), an honest-to-goodness chopped BBQ sandwich, and a tall glass of sweet iced tea (otherwise known as the wine of the South).

To tell the truth, I was looking forward to spending some unhurried alone time with my brand new 2010 US Andex chart.

Image copyright Andex/Morningstar

I love charts. I can spend an hour with a good chart and come away with having had as much enjoyment (and learning as much) as reading a well-written book (for my current new favorite, shown right).

The Andex chart shows what would have happened to $1, had it been invested way back in 1926, in a bunch of different indexes representative of tangible investments (US Small Stocks, S&P500 Total Return Index, Balanced Portfolio, World Stock Markets ex US Total Return Index, Long-Term Government Bonds, 5-Year Fixed-Term Investments, 30-Day Treasury Bills, and that darned old dog, Inflation, sorry Enzo).

As if that wasn't enough, the chart also shows: median PE ratio, minimum wage, the price of a first class stamp, gold, the price of oil, prime interest rate, and inflation. That's not all: dotting the nearly 85 years of time were hundreds of events, panics, assassinations, wars, crises, bombings, collapses, deficits, unemployment, Watergate burglars, hostages, bailouts, bankruptcies, market closings. It shows the day the first international mutual fund was introduced in the US and the day John Glenn orbited the earth.

All of the above is not the half of it, you need to get a copy of the chart for yourself or drop by our office and spend an hour or two with it. In the words of Jack Bauer, I promise you, it will lower your blood pressure and your heartbeat; two numbers that I imagine have been higher than they really ought to be. Why, because it gives you a 30,000 foot view of things and lets you know that today’s headlines are rarely the same as what history’s judgment is going to be.

It was after 2:30 when I gathered up my belongings (today's News-Record, my PDA, and my new friend the Andex Chart, when I noticed several waitresses and busboys and one cashier, who apparently had just spend the last half hour or so gawking at some guy in a Seersucker suit, eating a hot-dog and a BBQ sandwich and pouring over a chart with as many squiggly lines (and as big) as a road map. The cashier became their spokesman, she took a step toward me and peered at the chart: "I saw the market was up 175 points this morning, what it is gonna do?" "By when," I said pleasantly and sincerely, hoping to draw her out. "Oh, I don't know, I guess by when I retire," she admitted, seeing I was for real. "We have a 401(k) plan, you know."

Judging she had at least 15 more good working years on her side, I said, "Keep your head down, your heart up, and take advantage of buying more shares month in and month out." "Thanks, she said, that's just what I thought I'd do." She added, "And that's just what our guy says to do, too. You know he comes to see us when the market us up and he comes to see us when the market is down, and he always tells us the same thing. I don't know how people without an advisor do it."

"I don't either," I replied, "Put an extra scoop of ice-cream on his peach cobbler next time he comes in. And thank him for telling the truth.”

If all this volatility has you down, drop us a line, give us a call, or come by and see us. We'll talk about risk and return and how we're guiding investors through this mess, how to turn this crisis to your advantage. It never hurts to have a second set of eyes, especially in this environment.

And then we can go to Stamey's and enjoy a hot dog and a BBQ sandwich and a sweet iced tea.

You Think You're Paying Too Much In Taxes?

2010-06-09T09:21:00.006-04:00

Justin here. For all its quirks, it's hard to find a better (and cheaper) place to easily track what you spend that at www.mint.com. On top of that, the Mint blog does an equally great job at relaying financial concepts in easy to understand methods; today's post doesn't disappoint.

Note that the y-axis numbers are misaligned with the chart for some reason, but the meat of the chart is still right (for those of you who don't remember, the "y" axis is the vertical axis, also known as the "yo-yo" axis because it goes up and down . . . how about that?)

Personal Finance Sofware Mint.com

Congress Waivering on Fiduciary Issue

2010-05-25T08:56:00.003-04:00

Justin here. An article last week from WSJ's Jason Zweig highlights what fiduciary duty means to Joe Investor. The element of how congressmen play into the reform is interesting. After seeing how Senator Colburn trades his account, it seems a lot like letting my two year-old decide her bedtime . . . or if she has to hold my hand when she crosses the street (depending on how important you think fiduciary duty is.) Full article here.

In a recent interview with the Journal's Brody Mullins, Sen. Tom Coburn (R., Okla.) said that most of his money is managed by a professional adviser. The senator explained that his portfolio is heavy on oil and natural-gas stocks because energy is big business in his home state of Oklahoma.

Sen. Coburn added that he has his own account at TDAmeritrade, valued at about $70,000. He said he trades actively based on tips he gleans from Jim Cramer's "Mad Money" show on CNBC.

In 2008, Sen. Coburn traded Transocean four times in less than a month on Mr. Cramer's advice. "I lost my shirt," the senator said. He fared better with Tyson Foods, which he bought on Nov. 20, 2008, and sold less than three weeks later. "I bought it and got out because it went up," Sen. Coburn said. He added that he regretted selling Tyson so quickly, because its price kept rising after he sold.

Grantham on Bubbles

2010-05-11T16:52:00.003-04:00

Justin here. I'm fairly certain that all the 1000+ hours I spent studying for the CFA and CFP exams might have been better served taking a class on "How to Speak with a British Accent." Jeremy Grantham is brilliant (see his bio here, and latest commentary here) but his accent adds a good 20 points in perceived IQ.

The following short (6 minute) video discusses bubbles, how to spot them, what purpose the serve, and how "bloody mad" you have to be to buy into one. Y'all enjoy.

http://link.brightcove.com/services/player/bcpid71778049001?bclid=69928231001&bctid=79128759001

When Emotions Get the "Worst" of Us

2010-04-23T16:44:00.000-04:00

Dan Ariely is the James B. Duke Professor of Behavioral Economics at Duke University and author of the New York Times bestseller Predictably Irrational. And to my delight, one fortunate night last year, he was a friend who just happened to stop by my house for dinner. We sat around the dining room table with my wife, our son Justin, his wife and their one-year old daughter. We talked about, among other things, the irrationality of stock prices, the packaging of laundry detergent, and the sleep schedules of toddlers. Take solace that Ariely, a highly intelligent professor and author with doctorates in marketing and psychology, could figure out complex problems involving emotions and economics, but was still trying to get a toddler to sleep through the night.

Ariely and I met at a lecture two years ago. I was intrigued by the focus of his studies: how people behave in the marketplace compared with how they would behave if they were completely rational. His interests span a range of ordinary behaviors: buying, saving, ordering food in restaurants, pain management, procrastination, dishonesty – all under different emotional states.

In a recent Harvard Business Review, Ariely explained how he and research partner Eduardo Andrade set out to prove how one’s past emotional decisions can negatively influence future decisions. Participants were divided into two groups: Group A saw a five minute segment from the movie Life as a House, a clip known to irritate and annoy its viewers. Group B watched a five minute segment of the popular TV show, Friends, known to evoke happy feelings. After that, they played the Ultimatum Game in which the “sender” (Ariely) has $20, and offers the “receiver” (the movie watcher) a portion of that money. Sometimes the offer was fair (you get half and I’ll get half) and other times it wasn’t (you get $5 and I’ll get $15). If the receiver rejected the offer, both sides got absolutely nothing. To make a long story short, the agitated group rejected more offers than the happy group. Even though it was highly irrational behavior, the agitated participants preferred to lose free money in order to punish Ariely for making an “unfair” offer.

Now the really interesting part: after Ariely and Andrade gave the receivers time for their emotions to settle down, they played the game again. The previously annoyed group, now no longer irritated, still rejected far more offers than the happy group, who was now no longer glowing from watching Friends. Why? Because the members of each group had tapped the “memory” of decisions they made earlier, without any regard to whether they were under the influence of being annoyed.

All too often, we see aggravated emotions creep into markets like a fog, turning seemingly easy decisions into difficult ones. If that weren’t enough, we see that the lasting effects continue to obscure the judgments of many, even when the aggravation is long gone. A few years ago, investment banks became frustrated by the low returns offered in the market. So they invented financial products and increased their leverage, sometimes loaning out their capital 30 times over. In effect, these banks were fearfully wrapped up in the potential for lost future profits and made the irrational choice. Sadly, this “experiment” didn’t carry the warning “Don’t Try This At Home!” Homeowners became increasingly irritated by their neighbors, brothers-in-law, and people from TV shows like “Flip That House” making loads of money. That aggravation propelled them to put on the blinders, assume home prices would rise forever, lie about their income, borrow more than they could ever afford, and put themselves squarely in harm’s way.

Likewise, at the end of 2008, Joe and Jane Investor were staggering under the weight of their irritated and annoyed emotions. Every time they opened their statements or turned on the TV, they saw a smaller “number” than the day before. It was hard to see the rational point of view: that the world wasn’t going to end, that P/E multiples were historically low, that stocks were extremely underpriced and that US Treasuries were fairly overpriced. Just like in Ariely’s experiment, investors seemed to be offered $5, free and clear, but turned it down because of emotions rather than rationality.

The irrational behavior continued into 2009 and by all measures appears to still be present today. The Vanguard Group reported that January 2010 was the first month since January 2009 that more money flowed into their stock funds than their bond funds. And according to the Investment Company Institute, it seems that most of the rally was the result of mutual fund managers putting their large cash reserves to work, rather than new investors entering the market. Meaning, when stocks were cheap, investors plowed money into bonds, but once stocks got more expensive, investors decide to buy again. It’s not surprising that Joe and Jane are once again aggravated. They have missed most of the rally and seem willing to buy any stocks, regardless of the business quality or dividend yield.

So, how do Joe and Jane avoid making irrational decisions? Let’s go back to Ariely’s study. Imagine if the aggravated subjects were allowed to consult their most trusted advisor and even let that person make the decision for them. It doesn’t matter if the advisor was their pastor, hairdresser or bartender, as long as they were very rational (i.e. they weren’t affected by the aggravating movie clip), highly qualified (i.e. they knew that $5 was better than $0) and held to a fiduciary responsibility (i.e. they were solely devoted to making sure the subject made the right choice). I can almost guarantee than the instances of irrational behavior would plummet, hopefully to zero. In essence, that’s our job. Our mandate is to think and act as that most trusted advisor for our clients – giving rational, qualified, fiduciary advice and direction.

Then how is Jonathan Smith & Company making rational decisions in this market? As we’ve mentioned in recent commentaries, investing rationally today involves: buying high-quality stocks with correspondingly high-quality dividend focuses, owning corporate and high-yield bonds with less inflation risk than treasuries, and aligning our clients’ overall expected risk and return with their respective stomachs and wallets. Perhaps the most meaningful way we’re making rational decisions is by knowing our clients well and helping them navigate their financial lives in a personalized way. We ask everything from “what will you regret on your deathbed?” to “what’s your credit card debt and interest rate?” We inquire about their history of investing and the things that keep them up at night. And we try to impart our experience and knowledge by addressing issues from “how commodities act as a diversifier” to “how to pass on financial wisdom to your kids.”

And if that doesn’t work, we always have a DVD queued to a clip of Friends. For some reason, that usually seems to put everyone in a good mood.

Asset Allocations, Starting Points, and Diversification

2010-04-22T09:21:00.003-04:00

Justin here. I ran across this great (short) video from Roger Ibbotson (the unofficial father of market research) about asset allocation, starting points, and diversification. At JSCO, we talk a lot with clients about how much an investor's return depends on valuations when they start. Investing last year when all valuations were low was a no-brainer. Investing today, when valuations are inflated, takes a bit more precision (throwing darts at the WSJ won't do.) Ibbotson brings up a good point when he mentions bonds' relative historical starting point.

See it here: http://www.morningstar.com/cover/videocenter.aspx?id=328583&sr=wt0110

Why Financial Plans Are Worthless

2010-03-18T10:25:00.004-04:00

Carl Richards is a CFP Professional who blogs about financial matters at his own site, Behavior Gap, and on the Bucks portion of the NY Times online. He really understands what's important with plans, planning, and the whole process. And for those of us who think in Venn diagrams (can I see a show of hands? One, two, . . . ok, so all two of us) he usually has a treat like the one below.

His newest post "Why Financial Plans are Worthless" is especially good.

Warren Buffett on Gold

2010-02-17T21:38:00.001-05:00

“It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

Top 10 Investment Tips from the Ancient Texts of Classic Rock ‘n’ Roll

2010-02-02T15:57:00.004-05:00

Justin here. I found this absolute gem of a article on the CFA Institute's website. Written by Thomas Collimore, CFA, (Director, Investor Education for CFA Institute) it has some great tips and might even make you hum some classic rock. Here's a sample:

8. “Lady Madonna,” The Beatles (1968)

“Lady Madonna, children at your feet,
Wonder how you manage to make ends meet.
Who finds the money when you pay the rent?
Did you think that money was heaven sent?”

Plan, plan, and then plan again. Committing yourself to a realistic investment plan requires understanding your resources and obligations as well as the essential attributes of your future desired lifestyle. As you plan your investment strategy, leave room for investment underperformance. Committing your plan to writing may force you to address issues that you might otherwise glide over.

Go here for the full list of tips inspired by hits from bands like The Eagles, Led Zeppelin, Rolling Stones, and Aerosmith touching on topics such as Expenses, Longevity Risk, Taxes, and Professional Designations. It's rare to find something worth reading that's this easy to read. Good work Mr. Collimore.

The 'Are You Unemployed' Game Show

2009-12-07T08:57:00.005-05:00

Justin here. The folks at Mint.com have done it again. Here's a great video explaining real unemployment. Kinda makes you think that the "great" news last week wasn't all it was cracked up to be.

Everything I Needed to Know . . .

2009-11-26T12:30:00.005-05:00

Justin here. Everything I needed to know about fighting a recession, I learned from Tate Street Coffee House. I took this picture the other day while drinking my regular coffee (w/ half and half, spenda, and a packet of raw sugar); it says it all:

Innovate - See the bar there? TSCH is offering wine and beer now. Not just Keystone Light either, but an organic brew made from hops grown by owners Matt and Anne. Brilliant.

Do it Yourself - See that guy painting the ceiling during business hours? That's Matt, the owner. He does a bit here, a bit there. Never closes down business, never pays painters. And it gives the customers something to talk about and check in on. Two Birds/One Stone.

Know Your Customers - Again with Matt . . . he, Anne, and the other employees seem to know everyone by name and they ask about their interests and genuinely want to know their customers. I've rarely seen it done better.

Who Is Paying Taxes?

2009-11-24T10:51:00.007-05:00

Justin here. We're getting near year-end and so taxes are on the brain. I ran across this graphic from Mint.com. They do some really great visual explanations (they recently did one on reverse mortgages) but, seeing as though my second language is "Charts and Graphs", they could probably make a diagram about paint drying and I'd be fascinated. Enjoy.

Personal FinanceSoftware – Mint.com

Paul Krugman Thoughts

2009-11-04T11:20:00.007-05:00

Justin here. I went with a friend last night to see Paul Krugman speak at the Guilford College Bryan Series. I've got a number of things on my plate today so my review/thoughts will be brief.

Best Quote: "We can no longer make money by selling each other houses that we bought with money we borrowed from the Chinese."

Second Best Quote: In talking about the similarity between the US and Japan he said something to the effect of "With the exception of our raw fish consumption, we're pretty similar. Both democracies, both have hard working intelligent citizens, both have politicians who aren't the best but aren't idiots."

Comment That Provoked a Slight Gasp from the Woman Beside Me: when answering a question about the N.C. furniture industry, Krugman said he couldn't imagine an industry that is so labor intensive lasting so long in a high wage country like the US. And he followed that up with something to the effect of "before you get too worked up about that, remember that it's only here because the high wage North East US forced the jobs south to cheaper labor." As if to say, this is only a pit stop on the way further south.

Cold Sweat Inducing Statistic: 55% of commercial loans that are to reset in 2014 are underwater. And that's considering that they started with an extremely low Loan/Value ratio that would certainly need to go up if they get rolled forward. Makes me think of a number of friends in the commercial real estate business as well and the impacts that has on other industries.

My Question That I Didn't Get To Ask: what do you do with your excess income (i.e. how do you invest)?

Overall message:

He talked about how we got into this mess ('shadow banking', poor regulation, leverage),
How this was/is a global crisis (Spain, UK, even countries without bubbles felt it because they were connected.)
What we did right (cut interest rates, stimulus, flexible fed),
How we get out this crisis quickly (no silver bullet that will save us like railroads, world wars, and IT did for recessions past . . . only remote quick fix could be green technology, but even that has a lot of barriers and lag time, and 10% unemployment is a HUGE number will take a lot of GDP growth to get over),
How, more likely, to get out of it slowly (possibly unions (which, to my surprise got a round of applause), possible further stimulus, cut interest rates if we could go any lower)
Final point was that Keynes said "the shortage of capital through use, decay and obsolescence causes a sufficiently obvious scarcity to increase the marginal efficiency" meaning that our ipods will break, our computers will become slow, and our tires will wear out. Although slow, this process will create demand and innovation.

Politics aside, it was a good talk. It reinforced our slow growth thesis and our propensity to seek quality dividend paying companies as well as opportunities outside the US and in fixed income.

"If not for Veteran, I have no place to come to"

2009-10-31T12:35:00.019-04:00

Some events are so enormous that history’s judgment erects a permanent monument; something that remains long after all the eye witnesses are gone. Last Saturday, I boarded US Airways Flight 9092 to Washington, DC as part of the Triad’s Flight of Honor to take 101 World War II Veterans to see such a monument, their monument: the World War II Memorial.

I was chosen to be one of thirty-six guardians, each of us assigned to accompany three of the Veterans (pictured, myself in red). Before the flight, knowing that seniors prize familiarity, I made an effort to both call and meet my 83, 86, and 91 year-old companions at the ‘pre-flight’ meeting. When the eldest couldn’t make the meeting because he was under the weather, I drove out to his home. I learned how much the last ten years have demanded of him, but I got to hear a lot of happy memories too, and I could see that the more we talked, the better he felt. The only problem, I learned, was that the t-shirt he’d been given for the trip was an XXL but he needed an L at most. Before I could reel back in my words, I told him I’d take care of it.

After finding out there were no more shirts available, I called the seamstress who has repaired my dress shirts over the years. “Could you take a size XXL and make it into a size large?” I asked. “Sure,” she said, in broken English, “You bring large t-shirt too when you come, ok? When you come?”

Ten minutes later, the owner of Alternation Studio, a petite Vietnamese woman and I were comparing a size L to the size XXL. The shirt had the Flight of Honor logo, which she asked about. “Honor Flight,” she said, “what this?” I offered the short answer. “This you wear?” she asked. “No, no, my 91 year-old Veteran friend will wear it when we go to see the World War II Memorial in Washington,” I answered. “Veteran,” she said, her mind working, “I do for him, yes,” and with a bigger smile, said this powerful truth, “If not for Veteran I have no place to come to.”

Two days later, as promised, she produced the transformed size L t-shirt. Knowing how no one likes to wait for something, I delivered the shirt on my way home. At first I had a little trouble explaining how a t-shirt labeled XXL was really a size L, but when he understood that it had been remade just for him, you would have thought he just made a hole-in-one.

Other than t-shirt alterations, the job description of guardian was to accompany the Veterans through airport security, help them board and disembark, sit, walk and talk with them, point out access ramps and restrooms, tote cameras and pill bottles, provide an arm to lean on, circle up chairs under a big tent, and secure our box lunches. But much more importantly, we were there to listen, offer strength, and stand by them as they, the heroes, gazed into the Memorial, reflected on their own thoughts, and opened up the history books of their lives to us on that magnificent day not one of us will ever forget.

I haven’t been able to get that day out of my mind. It was such a privilege and honor to be with those men on such a gift of a day. But I’ve also been thinking about how much my job that day mirrors our job here, as Financial Guardians. We listen and plan, we direct and monitor, we share highs and lows, and offer our support and strength through all the stages of life’s journey.

This year has been a journey indeed, and our job as guardians has never been harder or more needed. Seven short months ago, a media-dominated, worried nation wondered if this time the headlines might be right. Investors whose parents lost everything during the Great Depression told us so. Fear spiraled. Sellers sold, buyers backed away. Stocks skidded, hitting low levels not seen in many years. As advisors, we bore down to figure out what our investments were really worth and what was really driving the market. The answer: bad news begat fear begat selling begat more fear and so on. We remembered John Templeton saying, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” We clung to that, hung on to our positions, owning more stocks than we normally would, while strategically moving up the quality chain and diversifying away some risk. We waited for rationality to return, figuring it could be many quarters or years away.

Then out of nowhere, here we are today (written 10/6/2009): the S&P500 is up nearly 20% for the year (and up nearly 60% off the March lows), corporate bonds are up nearly 15% and 10 year treasuries are down 6% year to date. Again, we have to ask where we are, how we’ve gotten here, and most importantly what it means to be a guardian. Our short answer: the market has gone far past “fair value,” mostly on the backs of low-quality stocks, and caution is the order of the day.

A Low-Quality, Speculative Rally. Like a tightly coiled spring, the assets that were most depressed in 2008 and early 2009 let loose when the world did not, in fact, come to an end. Any way you slice it, this six-month rally has been driven by the lowest-quality assets (in both stocks and bonds). Small stocks have outperformed large stocks, Newspapers and Financials have outperformed Regulated Utilities, and, most telling, No Moat stocks have outperformed Wide Moat stocks (for more about moats, see our Q1 2009 commentary “What’s Really Important: Price, Moat and Uncertainty).

Instability in the Background. Throughout this rally, we’ve seen large improvements in the real economy, but we’re nowhere close to out of the woods. After shooting up to record levels, the personal savings rate has slowly drifted from 5% in June, to 4% in July, 3% in August and although September data is not yet available (written October 6, 2009), our best guess is that the trend continues. Unemployment has crept up to 9.8% (and even that number doesn’t capture the underemployed and discouraged who are no longer looking for work.) The government has promised a $1 trillion per year deficit for the next ten years. Housing and Consumer sales have been temporarily bolstered by government programs that are all but over.

Caution is the Order of the Day. The need for caution doesn’t just come from the gloomy statistics mentioned above, but it also seems that caution could provide very satisfactory absolute (not just in raw numbers, we see the market as a whole selling for approximately what it’s worth (102% of fair value, see above.) However, the businesses with Wide Moats are selling for 88% of fair value (a 12% discount!) in contrast to the No Moat businesses that are currently overvalued (109% of fair value). Using the same yardstick, the US stocks in our separately managed portfolios are selling for 74% of fair value, with a 3.4% dividend yield on top of that. We structure these investments along with foreign stocks, domestic and foreign bonds, commodities, and real estate to provide our clients with a diversified portfolio that delivers a large portion of its expected return in the form of interest and dividends (which can then be used for income needs or reinvested in the market.)

I have a good friend who could probably sleep through a jackhammer pounding in the next room, but if he heard a set of keys rattle in the middle of the night, he’d shoot straight out of bed. Why? He was a prisoner of war for a long, long time. Although he learned quite a lot during those solitary years, he never quite learned to like the sound of a jailer’s keys. As guardians, we’re constantly learning to ignore the sound of the jackhammer, however loud it gets, and listen for the keys that the average investor might miss. Seven short months ago that jackhammer was unmistakable: “sell now, get out, run for cover.” We mostly ignored the rumble of the pavement and thankfully went about our business. Today, the jackhammer is a little more subtle (mostly from uncertainty), encouraging the investor to “seek the highest risk, make up lost ground” without regard for what the investor can stomach financially or emotionally.

We recently met with a client who, while happy with her portfolio going back up, wondered if she’d ever get back to the high water mark. That’s the sound of the jackhammer. We reminded her that we were accomplishing her goals now: producing a dependable income stream that meets her needs, on the backs of high quality, diversified investments that still have plenty of potential to appreciate. Now, that’s the sound of the keys jiggling that many investors miss. She quickly recognized the difference and wanted to pursue meeting her real-life goals, rather than just a number.

And even though we’ve been financial guardians for nearly three decades, we never know what Mr. Market’s next move will be; that’s a fool’s errand anyway. But, we do know that businesses that tend to produce high returns on capital will increase in intrinsic value over time and that those companies will tend to outperform the market. We know that owning investments across a number of different asset classes smoothes out the volatility of returns. We know that we sleep better when a large portion of our expected return is being paid in the form of interest and dividends. And we know that we’ve never felt better positioned for a quickly changing and uncertain world.

Risk Appetite Hits Highest Level in Over Three Years

2009-10-16T10:03:00.001-04:00

Warren Buffett said Occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics is equally unpredictable, both as to duration and degree. Therefore we never try to anticipate the arrival or departure of either. We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.

Seems like the speedometer is going fro "Zero to Greedy" in 7 months.

Risk Appetite Hits Highest Level in Over Three Years

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Surprise Call From a Congressman

2009-09-02T16:27:00.005-04:00

Justin here. Congressman Howard Coble has been in US House about as long as I've been out of preschool. He's on our quarterly mailing list and knows Jonathan fairly well (I don't think it's just because he requests a new flag every couple of years, but maybe.)

You can imagine my surprise today when he called asking for me. It went roughly like this:

Congressman Coble: "Well son, I got your press release with your recent commentary and was just calling to congratulate you on the CFA."

Me: "Well, thank you sir."

Congressman Coble: "Now that was pretty hard wasn't it? How long did it take?"

Me: "About 3 years and a thousand hours."

Congressman Coble: "Yes, I don't imagine they're just handing those CFA's out in the restroom stalls, now are they?"

Me: "No sir, not in any of the restrooms I've been in."

What a surprise joy. Something happens in a phone call, letter, or meeting that just can't happen over facebook, twitter, LinkedIn, or even email. I'll try to remember that.

What's important Part II - Dividends, Diversification, and Safety

2009-08-25T17:18:00.002-04:00

Jonathan here: One of the two best best ideas we've ever had is having an enduring investment process. The other is focusing more energy and resources on process than on outcome. In What’s Important Part II, we explore three ordinary but frequently underestimated components of an enduring investment process.

Our part of the world gets, on average, 43 inches of rainfall each year. That’s too much to worry about the price of rain barrels going up, but not enough that your average gardener can really trust Mother Nature for all watering needs. It seems the popular and cost-effective solution of choice is Drip Irrigation. My introduction to it was nine years ago, in Sacramento, California. My son-in-law hooked up miniature hoses and nozzles, which sputtered, stuttered, and sprayed a fine water mist for three whole minutes twice a day, onto ferns, banana trees, morning glory, oleander, hibiscus, and bird of paradise. His “backyard” was literally a beautiful pool and a cement pool deck with huge terra cotta pots containing mammoth plants. I was astonished that the plants flourished in these conditions. Seriously convinced, once home I visited Lowes in search of all things drip irrigation. I threaded rubber hose no thicker than a pencil through a maze of rhododendron, yew, azaleas, hydrangeas, moon vines, morning glories, black eyed Susan, cardinal vines and impatiens. I attached, at various intervals, micro sprinklers and nozzles, balanced the water output with Y-splitters, and screwed into the nerve center of this hydroponic contraption, one battery operated Gilmour automatic water timer.

But not every gardener has it so easy (so to speak). Parts of California, Nevada and New Mexico, for instance, get between 8 and 16 inches of water per year. There’s a saying that farming is just gambling in slow motion – you have to wait nine months to find out if you’ve won. Recently, Morning Edition featured Zach Sheely, a farmer who can’t afford to place a bet on (or wait nine months to find out) whether he waters too much or too little. Sheely uses a system designed by PureSense (pictured right) to help him rebalance the moisture levels on his 10,000 acre, California vegetable farm. “Using probes, sensors, weather instruments and meters, PureSense calculates the moisture and nutrients in the soil; it uses the Internet to send the information to servers, and then uses software to analyze whether or not the crops are getting the right amount of water.” The data is then transmitted wirelessly to Sheely’s iPhone; he can literally make it rain on any section of his crops with the tap of a button.

The principles governing agriculture and investing are much the same. Plant the best seeds at the right time in good soil, then water, fertilize, weed, thin out, protect against threats, harvest, enjoy, repeat as often as necessary. Too much or too little of any of these activities can create undue risk. But, hit the right balance and you stack the odds of reaping a harvest in your favor. In our last commentary, we outlined six “prism tweaks” we’ve put in motion. We discussed, in detail, the importance of Price, Moat, and Uncertainty; this quarter, we’ll cover Dividends, Diversification, and Safety.

Dividends. Sometimes it helps us to think about investing in terms of being a gardener who sells vegetables, whole vegetable plants, and potted flowers at the local farmers’ market. On any given Saturday, she can decide to sell her hand picked vegetables (which, in investing, is similar to collecting dividends), or she can sell a whole plant (selling a dividend paying stock), or she can also sell her potted flowers (selling a non-dividend paying stock). The problem the gardener faces with buying and selling too many potted flowers (buying non-dividend paying stocks) is that the only way to make a profit is if her buyers think the flowers are worth more than she paid for them. That’s all well and good if her time horizon is long enough or the market for plants is stable. But what if (like many investors today) her time horizon is shorter and the market for plant buyers isn’t especially stable? Or what if the price of soil skyrockets or news reports circulate that recreational gardening is a health risk? People won’t want to plant in their gardens and prices of these plants will drop. If our gardener is depending on selling her plants (vegetable or flowering) for her income, she would have to sell them at an inopportune time. As advisors, we aim to set up our clients’ gardens (portfolios) in such a way that their vegetables (dividends) provide for the majority of their income needs and they aren’t dependent on the price of their plants (stocks) on the day they need income. There’s much more to dividends than finding the highest yield (for example, determining a company’s ability to keep paying it, management’s commitment to upholding it, and what we can expect in terms of its growth) but that’s for another commentary.

Diversification. Suppose our gardener needs to choose between planting squash, cucumbers, or both. She figures each will produce approximately the same amount of income for her and will need the same amount of sunlight, water, and care. The only difference: squash are susceptible to squash bugs while cucumbers are vulnerable to cucumber beetles. With an equal chance of either insect showing up hungry and harming a crop; it makes sense to plant both squash and cucumbers while still trying to ward off both insects. This is the case not only for stock diversification (owning more than just a handful of stocks), but even more so for asset class diversification (owning more than just a couple asset classes such as US Stocks, Bonds, Foreign Stocks, Commodities or Real Estate.) While it does get more complex meshing multiple asset classes, the outcome is still the same. An investor can take a number of inherently risky assets and combine them in a portfolio that delivers the highest expected return for a given level of volatility (determined by what the investor can stomach both financially and emotionally.)

Safety. Sometimes, what could seem safe (taking shelter in a storm under a tree or taking money out of stocks last March) can actually be the most dangerous option possible (both “lightning” and “missing a 30% rally” can really knock the wind out of someone). As portfolio managers, we want to make sure we’re always learning from our mistakes . . . but just not learning too much. We’re conscious to look at the important data points, not the prevailing perception that might say seeking sustainable dividends, wide moats, and low uncertainty is being too “safe” to provide any meaningful returns. We might normally agree, however today is far from normal. We’re in a market where companies with the widest moats are selling for the largest discounts (78% of their worth) while the companies without moats, see chart, are trading for no discount (100% of their value).

Author Annie Dillard says “Danger is the safest thing in the world if you go about it right.” While investing is and will continue to be “dangerous” in terms of uncertainty and volatility, we’re confident that we’re “going about it right.” As we said last quarter, we’re doing that by: concentrating on buying undervalued assets (Price), owning businesses with sustainable competitive advantages (Moat), and investing in areas where we have a narrower range of outcomes (Uncertainty). By adding to those the areas we’ve covered this quarter, we’re able to take calculated risks that line up with our clients’ ability and willingness to take those risks.

Justin W. Smith, CFA, Earns Prestigious Chartered Financial Analyst Designation

2009-08-17T16:13:00.000-04:00

Greensboro, NC, August 14, 2009 − Justin W. Smith, CFA, a Financial Advisor at Jonathan Smith & Co., Investment Counsel in Greensboro, NC has earned the prestigious Chartered Financial Analyst® (CFA®) designation.

The CFA charter is a globally recognized credential for investment analysis and management. The CFA Program sets a globally recognized standard for measuring the competence and integrity of financial analysts, portfolio managers, and investment advisers. Currently, more than 82,800 investment professionals in 128 countries and territories hold the CFA charter.

Recipients of the CFA charter have successfully completed a graduate-level, self-study curriculum and series of three intensive examinations taken sequentially over at least two years. It is recommended that candidates prepare a minimum of 250 hours per exam, with substantially more recommended for individual circumstances.

Since the inception of the CFA Program 45 years ago, pass rates at each of the three exam levels have averaged about 50 percent. Because of the rigor of the program, only about one in five candidates who enter the program pass all three exams and successfully complete all the requirements to earn the charter.

Administered exclusively in English, the international language of business, the three six-hour exams cover ethical and professional standards, securities analysis and valuation, financial statement analysis, quantitative methods, economics, corporate finance, portfolio management, and performance measurement.

“This isn’t about adding three letters to the end of my name,” Smith pointed out. “At a time in the market where there is so much uncertainty, I’m happy to be able to do something that not only makes me a better advisor, but also gives our clients some added confidence in who they are trusting to get them safely home.”

“Five months ago, you could have picked a portfolio by throwing darts at the Wall Street Journal and had a great return,” Smith said. “But today, we think we’re looking at just the opposite. That’s an almost inconceivable shift in such a short amount of time. The CFA program has given me the knowledge, insight, and persistence to tackle this ever-changing investment landscape.”

And if his day job weren’t enough, he’s got a full load on his hands at home. “I’ve got a 115 year-old house, one toddler and another due soon, and a honey-do list that, due to the CFA exams, has been three years in the making,” Smith noted. “All that CFA work is going to seem like a breeze compared with what I have in store for me at home.”

Robert R. Johnson, Ph.D., CFA, deputy CEO, explained what motivates candidates to make such a significant investment of their time and energy to seek to earn the CFA designation.

“For more than 40 years, candidates have sought to earn the CFA charter for two chief reasons,” Johnson said, “one, to expand and test their knowledge of current practice across a broad range of investment topics, and two, to demonstrate to clients, employers, and peers their mastery of a demanding body of knowledge."

CFA Institute
CFA Institute is the global association for investment professionals. It administers the CFA and CIPM curriculum and exam programs worldwide; publishes research; conducts professional development programs; and sets voluntary, ethics-based professional and performance-reporting standards for the investment industry. CFA Institute has more than 96,000 members, who include the world’s 82,800 CFA charterholders, in 133 countries and territories, as well as 136 affiliated professional societies in 57 countries and territories. More information may be found at http://www.cfainstitute.org/.

Jonathan Smith & Co., Investment Counsel
Jonathan Smith & Co. is a Registered Investment Advisor providing investment counsel and financial planning for individuals, trusts, estates, corporations, investment trusts, employee benefit trusts, and institutions. Aware that each engagement’s wealth management needs are unique and often complex, they craft individualized solutions and simplify life's financial aspects for their clients. Their mission is to build, protect and manage each client's wealth through every stage of life. More information may be found at http://www.jonathansmith.com/.

I Probably Won't Be Dessert . . .

2009-08-03T16:58:00.006-04:00

Justin here. Professor Jeremy Seigel recently pointed out the difference between the fear of unemployment vs the reality of unemployment here:

"The June unemployment rate touched 9.5%, and it is quite possible that that rate will eventually exceed the 10.8% rate reached in November 1982. But even if it does, unemployment will rise, at most, 2 percentage points, far less than the reported 30% to 40% of workers who fear they will be laid off. And as the economy mends, the fear of being unemployed will subside, and consumption will rise."

Professor Seigel has forgotten more than I'll ever know about economics, but I have to (very respectfully) disagree. I think it’s unrealistic to think that Joe Consumer could have 10-20% more friends, family, and co-workers lose their jobs and then somehow he'll then breathe a sign of relief and start spending because some economists think that unemployment is already far above normal. I think Joe is going to pretty scared for a pretty good while.

It’s like being in a pit of lions that, on average, will eat no more than one human in a sitting. I don’t know about you, but if I’m stuck in there and two of my buddies were just eaten (mind you that's 100% above the average), mean reversion and bell curves won’t make me any less likely to need a clean pair of underwear.

What’s Really Important: Price, Moat, and Uncertainty

2009-07-15T16:37:00.000-04:00

Jonathan here. Been a busy quarter migrating to our new investment platform. Been meaning to post our 1st quarter Market Commentary since April when we wrote it. 2nd quarter Market Commentary in the queue.

I have a pair of Skyline 16x50 binoculars that belonged to my father-in-law, Conley. They feel great hanging around my neck or in my hands (certainly due more to my fond memories of their former owner than the superior design of their manufacturer.) Even though they are decades old, the magnification and width of field are superb. There’s just this one tiny problem: they create just enough double vision that you have to close one eye when you look through them. I still remember having to use them as a monocular so I could see Sam Snead lay up close to the pin on the 18th green at Sedgefield Country Club when Conley and I went to the Greater Greensboro Open years ago.

A while back I tried fixing my binoculars’ cockeyed view. Perhaps an objective lens or eye piece was cross threaded. Nope, they were screwed in fine. Asking myself “What’s the worst that could happen?” I took them all the way apart. Four tiny screws later, cover plates removed, I saw the problem: there were four prisms, seemingly held tight with little set screws, until one prism jiggled loose. Just one misaligned prism resulted in the distorted view.

I was reminded of my binoculars after an attorney friend of mine told me about a presentation he’s been giving to area banks. He’s committed to helping them work through this financial crisis and see the future of banking. When he talks, he holds a prism up high. He tells the bankers, “If you look straight ahead, where you’re accustomed to looking, you won’t see what’s straight ahead. If you want to accurately see what’s ahead, you need to turn the prism.”

Many of the troubles we’re experiencing in our economy are due to our nation’s tendency to look straight ahead and miss it. For example, we saw that Lehman Brothers was leveraged 25 to 1 while many investors and talking heads didn’t blink an eye because that’s how investment banks have always operated. And for years consumers shunned saving, but rather lived on their home equity and credit cards because their home values always went up and cheap credit was always available. And in the last year, we saw that a bank could combine a few BBB issues into a new CDO and the rating agencies would suddenly call it AAA because it was now a new security that was “relatively” safe. On the surface, these examples might look like instances of hindsight being 20/20, but they are really instances of past foresight being more like 20/180.

I wish we could say that, as advisors, our vision has always been stellar, but we can also be guilty of “looking straight ahead and missing it.” What is more important, though, is that we’re willing to open up the binoculars, adjust the appropriate screws, and go on viewing the golf match. We think the only thing worse that looking through a broken pair of binoculars would be to think either: a) we’ll get lucky and the golf ball might just roll into view or b) the binoculars are going to fix themselves.

So, what prism tweaks have we set into motion? They can be summed up in six areas: Price, Moat, Uncertainty, Dividends, Diversification and Safety. We’ll give some details of the first three in this commentary and the next three in the following commentary. If you can’t wait until next quarter to read about them, let us know and we’ll send you our thoughts ahead of time, or we can sit down and talk about them face to face.

Price. For years, price was our (and many other value investors’) end-all, be-all. We’ve been intent on buying “dollar bills for 50 cents.” The focus in this approach is more heavily on the stock and less so on the business. The problem is that this approach alone can lead to casualties if the investment’s time horizon and risk tolerance isn’t aligned with the investor’s time horizon and risk tolerance. We are still like a budget conscious grocery shopper: we know that it makes sense to buy cheap produce that has a few bruises on it, but we’re also conscious of some other factors that should get equal weight.

Moat. Moving up our chain of importance is a focus on a business’ economic moat. Warren Buffet said that a moat protects a “valuable and much sought after business castle.” Moats can come in many forms such as a well-known brand name, superior pricing power, or a large portion of market demand. While they come in many forms, all moats contribute to a common result: a company that is more likely to be in control of its own destiny. We recognize that there is plenty of money to be made in businesses without moats (many of us have built our livelihoods working for “no moat” companies). However, in this environment where the rules seem to change daily and confidence is here one day and gone the next, we believe it is wise to limit the number of factors that are outside of a business’ control.

Uncertainty. Another area garnering more weight in our process, is our level of uncertainty regarding the potential value of an investment. When I took up softball in my early forties, having never played baseball as a kid, my batting philosophy was this: close your eyes and swing, repeat if necessary. In investing, we have more control over the certainty of outcomes than I did in the batter’s box. Before we invest, we can choose to swing for either “homeruns and strike outs” or “singles and doubles”. Granted, sometimes swinging for singles and doubles will end up in a homerun and sometimes it will end up in a strikeout, but most of the time it’ll turn out just as intended: singles and doubles. Since our primary job is to help our clients sleep well at night, we are inclined to invest where we have a lower degree of uncertainty about the potential outcomes.

The most frequent question we’ve fielded after talking about any tweaks to our investment strategy is “isn’t this like shutting the barn door after the horse is already out?” It’s a great question; one we’ve thought through extensively. Our best answer is this: if someone would ring a bell today and announce with 100% certainty that the stock market can’t go any lower and we’ll have full recovery within months, then we would invest differently. The reality is that we haven’t heard any such bells announcing anything of the sort and, frankly, we could still see more unnerving news on the horizon.

We still think today is a great time to own U.S. equities, particularly companies with the qualities mentioned above (historically low prices, sizeable moats, and low uncertainty.) The potential returns we could see over the next ten years could be at levels not seen in generations. The problem is that we don’t all have ten year time horizons, and even if we do, the volatility is hard to stomach. This brings us back to the other three “prism tweaks” we’ve already put in place and we’ll cover next quarter: Dividends, Diversification, and Safety. These three allow us to (respectively): get paid to wait, smooth out the bumpy ride, and seek superior risk-adjusted returns. Again, our primary job is to help our clients sleep well at night and now, more than ever, that means investing for the upside and protecting against the downside.

Two Wrongs Don't Make a Right - Pension Insurance

2009-03-30T16:26:00.006-04:00

Pension insurer shifted to stocks - The Boston Globe
Posted using ShareThis

The article above gives me a pit in my stomach on a number of levels, but one in particular. I think most people would get sick thinking of the money already "lost" . . . I get sick thinking about the money that might not be gained.

I'd like to think that the Pension Benefit Guarantee Corp would operate under some pretty standard advice: if you need money in the next 5 years, maybe you shouldn't have it in stocks. I do think they need to be proactive and estimate if they'll have an onslaught of pensions to back and see if that changes their time horizon, but they also need to be able to face reality. With valuations where they are, it might very well make sense to "stay put" and not have Congress reallocate your portfolio.

As we say here: "Two wrongs don't make a right." From this observer's point of view, it seems like shift back to the old strategy right now might be wrong #2.

Note: The author recognizes that he does not possess the right mix of qualifications, connections, and unconfessed past sins that is required to work for the PBGC, the Government Accountability Office, or the Congressional Budget Office. Therefore, his opinions are merely that and should not be applied to your investment strategy or the government's investment strategy for that matter and frankly he's surprised you're reading this fine print.

Feeling Like the Dryer Ate My Socks AND My Stocks

2009-03-18T09:46:00.007-04:00

[UPDATED: I originally posted the entire article from investopedia here, but after brushing up on my copyright rules and regs (thanks to a couple colleagues) I've removed the article and just linked to it. Oops. Better safe than sorry.]

Justin here. I ran across a great article on investopedia.com (you can find the original here) that talks about where all our stock value "went".

The take-home is this: when so much of a company's stock price is determined by perception, there is real value and security in investing in companies that will pay you a dividend. People can argue all day long whether a stock is worth $5 or $50, but it is impossible to argue about the real value of the dividends that just landed in your account.

Once you start focusing on dividends, the main question becomes: "is this company (stock) able and inclined to pay a stable, meaningful, and growing dividend?"

We think that's a whole lot more productive and easier to determine than the non-dividend approach where the sole question is: "is this company going to be worth substantially more on the day I need to sell it?"

I lost the toss

2009-02-23T18:10:00.005-05:00

Jonathan here. My February 3 post, Will the Dow Set a New low in 2009, is the most stupid post I've ever written. Not because my thesis was wrong (it was), but in our line of work, focusing on process over outcome is what it's all about, and in the clarity of hindsight, I was focusing on outcome not process. So now that I've had my whipping, eaten crow, and been avoided at the water cooler by my colleagues, I wanted to share just a bit about what we know and think about market sentiment, or more precisely, investor sentiment. Sage investors know investors become buyers when the consensus gets cheerful. Warren Buffett said "you pay a high price for a cheerful consensus." Ben Graham, Buffett's mentor and teacher, urged his apprentice to "buy when there's blood in the streets", or words to that effect.

Clearly, anybody who's followed that kind of advice has had his head handed to him on a platter. For going on a year now, it seems like the crowd has been right and buyers or holders of stocks have gotten it all wrong. "Will this persist?" (like it looks like it will) is the wrong question to be asking. "How long will it last?" is, I believe, the right question.

We've heard that history repeats itself. With all the focus on what's happening now in the stock market, it seems that investors have, once again, pretty much discounted what's happened long, long ago. But that's not unusual; we're all prone to a bout with Outcome Bias every now and again. "It's different this time," we hear, ad nauseam. Yes, events are different this time. But human nature hasn't changed one whit in the last 1,000 years, and I seriously doubt it will before 2009 rolls to a close.

To that end, we've poured a lot of time into studying bullish and bearish sentiment and investor pain. Believing that investors really are predictably irrational, we want to learn what happened when investors sold stocks when everything was dismal and when they bought stocks when everything was rosy. I'm far from ready to offer any conclusions, but I'm happy to share our initial findings here.

If these charts pique your interest, your comments are welcome. Similarly, if you drop us a line, we'd be happy to chat.

AAII Sentiment Index

View more presentations from Jonathan Smith. (tags: sentiment market)

Investor Pain Index And Dow Jones Industrials

View more presentations from Jonathan Smith. (tags: pain investor)

If these charts pique your interest, your comments are welcome. Similarly, if you drop us a line, we'd be happy to chat.

Will the Dow set a new low in 2009?

2009-02-03T20:57:00.073-05:00

Call me old fashioned, but I think there are safer and surer ways to get paid while waiting than to own a contract, valued at approximately 79 cents on 2/3/2009, betting that the Dow will set a low that is lower than 7,449.38 sometime between now and year end.

With stocks at multi-year lows and investor pain at multi-year highs, I'm pretty sure that going long the Intrade contract is not a bet I'd want to take...but that's what makes a market. If I understand the value proposition correctly, the buyer who's willing to pay ~ 80 cents to own this contract, now believes that there's an 80% chance that he'll see lower lows than 7,449.38 sometime this year. Conversely the seller who's willing to sell this contract for ~ 80 cents now believes that there's a 20% chance that he'll see lower lows than 7,449.39 this year. See Disclosure and more beneath chart.

[Disclosure - Jonathan Smith doesn't own this, or any, contract on Intrade (or any other prediction market) and isn' making any recommendations, bets, conjectures, whatsoever. For the record, his dowsing stick isn't any better than anybody else's. Intrade.com is a prediction market, and much ado has been made by the media about prediction markets. In case you're wondering what sort of payoff the buyer of the aforesaid contract gets for his ~ 80 cent investment if he wins. The answer is $1.00. On the other side of the transaction, the seller who sold the contract got ~ 80 cents for being willing to pay a buck if he loses. After he subtracts the ~ 80 cents he gets to keep from the buck he might have to pay out, he'll be out ~ 20 cents, and so you could say he thinks there's a 20% chance the Dow will go south of 7,449.38 in '09.]

By the way, this chart used with permission by Intrade.com.

"The Worst Quarter Since 1931" - Q4 2008 Commentary

2009-01-22T10:39:00.009-05:00

The tremors that began over a year and a half ago in the mortgage market came to fruition in the stock and bond markets this past fall. The fourth quarter of 2008 was the worst quarter for the stock market in the 308 calendar quarters since 1931. Diversification, that friend of investors through thick or thin, did little to avert the damage. Even uncorrelated investments moved lockstep in one direction: down.

During the quarter, panicked investors fled any investment perceived to have risk. Prices of stocks and corporate bonds, under more pressure from sellers than from buyers, dropped to valuation levels not seen in decades. By November, under the weight of perpetual political campaigns, shorter days, and longer lists of bailouts, investor panic heightened. An index that tracks stock price volatility reached a new high last quarter, a level not seen since October 1987. Even money market funds were perceived as risky.

And then, at 8:30 am on December 11th, two weeks before Christmas, the world was stunned by the news of the arrest of Bernard L. Madoff on charges of running the largest investor fraud ever committed by a single individual. “The Madoff affair,” wrote Thomas L. Friedman, “is the cherry on top of a national breakdown in financial propriety, regulations and common sense.”

So if you’re looking for the recipe for that pit in the stomach of the average investor, it goes something like this: add once in a lifetime stock and bond market losses, throw in an investor scam of mammoth proportions, mix it with unprecedented government intervention, add a dash of a bleak economic outlook and a pinch of bank failures, top it all off with a depressed housing market and serve it up on CNBC. That’s more than enough to make us sick, and we haven’t even discussed foreign markets yet!

Given all that has transpired we keep going back to the basics, our research, and our calculators. At the forefront of our research we remember that in the best and worst of economic times emotions, not fundamentals, determine stock market prices. In contrast, during ordinary times, the underlying business values determine stock market prices.

What’s an investor to do? Follow his heart? By no means! Regular readers of this commentary know that we often write about our admiration for Warren Buffett. His investment approach has proven successful in good markets and in bad. He recently made headlines for writing an essay in the New York Times encouraging investors to “Buy American.” He said:

“The financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary. So ... I’ve been buying American stocks.”

Buffett is no cheerleader. A dispassionate investor whose primary job is allocating capital, Buffett has made serious comments about the market only four times in his career. The chart below demonstrates both his ability and his patience.

We agree with Buffett. We have seen businesses selling for less than the cash in the company – yet there are few buyers because buyers are fearful. When Wachovia Bank, an institution that did not close during the great depression, teeters on the brink of collapse and virtually eliminates their cash dividend, it’s hard to know whom or what to trust.

World governments have taken steps to improve liquidity and credit markets are beginning to function rationally. There is evidence the crisis is beginning to subside but the financial system is still fragile and the economic news is likely to be pretty grim for the next few quarters.

The question we have to answer is this: do we have the time horizon and patience necessary to hold a company’s stock until that company’s value is realized? When stock prices move up or down 25% in one day or even several days, it’s quite apparent that underlying business values aren’t driving those price changes; confused people are driving those price changes. At some point, panic will subside and investors will begin (again) to pay attention to asset values, and when they do, share prices will adjust. So far in 2009 we’ve already seen a number of stocks that have risen over 75% in just the first three trading days. This is a sign that panic is subsiding.

Going forward, we’re keeping in front of us the words of Nick Murray:

“Less than 5% of an investor’s lifetime total return will come from what his investments did versus other, similar investments. The other 95% will come from how the investor behaved, and the primary determinant of that behavior will be the quality of advice he got, or didn't get.”

We take seriously our responsibility to our clients and our responsibility for how we behave in the midst of a period of tumult. All of our research, experience, and instinct tell us that today is a day to be invested and not sitting on the sidelines. As Mr. Buffett said in the same op-ed piece, “A simple rule dictates my buying, be fearful when others are greedy, and be greedy when others are fearful.”

To read more commentaries and learn more about Jonathan Smith & Co., visit http://www.jonathansmith.com/resources.cfm

Sign of the times

2009-01-12T16:59:00.007-05:00

Jonathan here. This week the recession hit home. It’s official. We know this because the copper lights on our company sign were wrenched off their mounting posts this weekend. I guess when the price for recycled copper cratered from over $4 in June to just a little over a buck now, the copper poachers figured it’s not worth straining too hard for salvage copper when there’s plenty of low hanging fruit easy reach.

Another sign of the times, more reliable than my copper sign light index caught my eye.

The email invited me to check out Amazon.com's year-end book deals. “Save big on the books you love,” the teaser read. So I did.

I remember years ago checking out Amazon’s book deals. Once, I recall, Amazon was peddling John Bogle’s book, “Bogle on Investing," for something like 70% off.

Bogle the value investor had then just published a book about his first 50 years in the business (Bogle, you may know, was founder and CEO of the Vanguard family of mutual funds, and was, is, and forever will be impervious to any urge whatsoever to time the stock market.) With dot-com stocks then flying high, I guess Amazon figured who in their right mind would want to read a book about value investing of all things, which is probably why the cut the price and this little gem of a book wound up the bargain table.

In thirty-two years in the investment business I've never heard anyone ring a bell when we've reached the “top” or the “bottom” of a market cycle. What I was about to see made me wonder if Bogle’s “value investing” book (on sale for 30% of “fair value”) was as good as any “bell” I would ever hear. After all, that little priced book just happened to coincide with what history would recognize as the peak of the dot-com bubble.

“Save big on the books you love,” read the recent flyer. Drawn by the sidebar featuring bargain books in the very category I was sure to like (cooking), I bit. And there it was, just like (well, almost like) the one my mother in law gave us 37 ½ years ago: a Rival Crock pot and a copy of Rival Crock Pot: 3 books in 1, the most popular selling book in the bargain book cooking category, the 3rd most popular selling book in the cooking appliances category, and the 500th most popular selling book in the whole Amazon.com universe.

If Bogle’s book on the bargain counter signaled the bursting of the dot-com bubble, could the reawakening of stocks be too far behind the Rival Recession Index?
I was over at my favorite Sears store this weekend in the tool department in pursuit of a 21/64ths black oxide drill bit to finish drilling a light sign I made for Anne. Whenever I can't find what I’m looking for, an affable and able salesman named Jim is available to help me. Jim, I am sure, knows everything there is to know about tools and a thing or two besides. It's obvious he likes helping people, 3) works because, in his own words, “I’d go crazy if he had to sit around all day doing nothing,” 4) knows a heck of a lot about stocks and stock market valuations. He should. He’s 80!

If I’m lucky and Jim’s not too busy, I can usually pull a nugget or two of wisdom out of him, wisdom beyond that of the tool realm. And so I slipped my crock-pot theory on him, recounting how back in 2000, Amazon.com had slashed the price of John Bogle’s value investing book because, after all, nobody wanted it and now, Rival’s Crock Pot, paired with a three in one blockbuster book, was setting the slow-cooking woods on fire. “Jim,” I said, “How's the old the crock pot selling these days?” He cocked his head and looked at me as if I had read his mind. “Son,” he said, “we sold so many Crock Pots this Christmas we just about quit putting them up on the shelves and let the customers go outside and pick ‘em up off the truck.” He added that for a little while, he was pretty sure no one Sear’s customer was going to get a chance to get near a crock pot, on account of all of Sear’s employees snapping them up before they were released to the public.

Pick-a-Pay Loans

2008-12-29T09:29:00.005-05:00

Justin here. One of the worst financial inventions to come out of the housing boom has been the "Pick A Pay" loan.

Basically, the homeowner picks a payment they feel comfortable with, then they just pay it; it's as easy as that. You get a low payment, increasing house value, and big biceps (see picture) . . . well, not really.

What happens most of the time is that the homeowner is actually paying less than the interest! So the principal, instead of going down with every payment, actually GOES UP! You are essentially borrowing more money monthly. This was all well and good (though still not smart) while home values were rising. You can guess what happens when the house starts falling.

In May 2008, a San Francisco news station did a segment spotlighting the training videos that the company used (video here). It shows a scene where the homeowner asks the loan officer to clarify that he won't actually be paying down principal with this loan and the recommended response is "it's optional".

(Note: The company shown in the video was bought by another bank, which was bought by another bank, which then suspended the pick-a-pay program and then got bought by yet another bank.)

Recipe for Disaster: Keeping Up With The Joneses

2008-12-12T14:19:00.010-05:00

Justin here. The single best (and by far most fascinating) explanation I've found of the current financial crisis is This American Life’s The Giant Pool of Money episode that aired on NPR. (You can listen to the 30 second promo here, the full story here, or read the transcript here.)

Mostly because excerpts like this:

“I wouldn't have loaned me the money. And nobody that I know would have loaned me the money. I know guys who are criminals who wouldn't loan me that and they break your knee-caps. I don’t know why the bank did it. I’m serious ... $540,000 to a person with bad credit.”

It made me realized that the sole cause of the crisis (literally ... the ... sole ... cause) is this: the need to keep up with the Joneses.

At every level of the chain: from countries needing to boost their investment returns so they sell out of treasuries and go to higher yielding alternatives, to homeowners taking out mortgages and second mortgages because their neighbors and friends are, to mortgage brokers creating riskier and riskier loans because their competition are, to banks buying those mortgages because the other banks are buying them.

The desire to “keep up” overtook the need to act rationally. I urge you to read or listen to it. Below are some more excerpts (emphasis mine) and my key takeaway:

"An interesting fact, here. Mike Garner's bank did not care how risky these mortgages were. This was the new era: banks didn't have to hold on to these mortgages for 30 years. They didn’t have to wait and see if they’d be paid back. Bank's like Garner's just owned them for a month or two and then sold them on to Wall Street. Wall Street would sell them on to the global pool of money."

And this:

"No income no asset loans. That's a liar's loan. We are telling you to lie to us. We're hoping you don't lie. Tell us what you make, tell us what you have in the bank, but we won't verify? We’re setting you up to lie. Something about that feels very wrong. It felt wrong way back when and I wish we had never done it. Unfortunately, what happened ... we did it because everyone else was doing it."

And lastly, this about the current and future landscape:

"The global pool of money is avoiding anything with even the slightest hint of risk and that affects everybody, no matter who you are. It's harder to borrow money to buy a house, or build a factory, or bring your country boldly into the 21st century."

My key takeaway is this: things are generally not as good or as bad as they seem.

Translation: if Mr. Market underpriced risk on the outset of this mess (ie - he bought risky securities he shouldn’t have), is it so crazy to think that Mr. Market could overprice risk today (ie – Mr. Market might not be buying some low risk securities that he should be buying?)

The House is Falling

2008-11-18T15:29:00.011-05:00

Justin here. When my wife and I moved to Greensboro, we looked at 10 or 15 houses before making an offer on the cheapest one of the lot. After finding out there were two other offers, we paid the asking price ($129,900) for the 110 year old bungalow that had an abundance of charm and lead paint but skimped on the closet space and bathrooms.

Almost four years, one baby, 6 restored windows and a new paint job later, I'm still scurrying across the house at 6:00am to get to my closet, one that was made for a man with much narrower shoulders than me.

Anyway, when the stock market is moving like it is now, we've found it helpful to think about stock prices in terms of home prices. We've often asked clients, "What if you had a ticker running across your screen telling you what your home was worth? What if Jim Cramer screamed about your home price on TV? What if Barron's did a story about how overvalued your house was?" You'd start to believe everything they say.

Enter Zillow, a website that is supposed to track the daily price of your house. Zillow has been out a while, but I only got around to looking up my house in the last few months (below is the 5 year chart, that circle withe the $ is where I bought the house.)

And when I looked at it, do you want to know what I felt? Regret. Seriously. I regretted buying it for more than zillow said it was 'worth' ($115,000) and regretted not selling it in May 2008 when it was 'worth' $164,000.

But, you want to know what else I felt? Relief. Seriously. I was relieved to not have gotten the email, seen the quote, or heard the news that my house was 'worth' only $120,000 in February of 2007. Relieved that I didn't panic and sell out after it "when down" 15% from my purchase price. Relieved that I knew what my house was really worth and didn't sell for less.

And then I realized that looking at Zillow is no different than reading a stock analyst report, listening to a talking head, or checking your stock portfolio daily. The analysts and talking heads might sound slick and have a clean looking chart, but chances are they don't know the real value. And your stock portfolio today is only a snapshot of what someone will pay you right now, not a true measure of what is is worth. We think the prices we'll see in 6, 12, 18, 24, heck even if it takes 36 months (which is still long before the bulk of us will need to use our investments) will tell a much different story that the 'quotes' we're getting today.

Try telling the seller of my house that it was only worth $115,000 the day before he sold it - that's what Zillow said it was worth. I think he'd argue that my bank's check to him for $129,900 is a lot more accurate than Zillow's "quote." For him, his house ended up being worth about 13% more than Zillow quoted. Would it surprise you if we had the same thing going on in the stock market today, but on a much larger scale?

Ben Graham, the father of value investing, Mr. Market, and Warren Buffett's investing career, once said:

"The investor who permits himself to be stampeded or unduly worried by unjustified market declines . . . would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons' mistakes of judgment."

Words worth remembering, especially now.

Question: What Are You Doing?

2008-11-18T10:19:00.007-05:00

Justin here. American Public Media's Marketplace has been asking different people that question ("what are you doing?") since the start of this financial crisis. Today, they asked one of our favorite people: Dan Ariely

In this three minute 'interview' (listen below) Dan says that he has decided to not look at his investment statements. His motivation is more for peace of mind than anything else. Dan found that when he looked at his dwindling account it put him in a bad mood. In other words, worrying about it didn't add a single day to his life (those are my words, not his . . . well, not really even mine.)

We'd agree with Dan's advice . . . but with a caveat. We think two of the keys to successful investing are 1) finding a person (or process) that you trust and 2) sticking to them (or it.)

The "leg-work" is done in step 1 and "stomach-work" is done in step 2.

So, if you've done your leg-work in step 1 (picking a sound, rational, time-tested person or process), then the stomach-work in step 2 should be easier (not easy, just easier).

However, if you've been willy nilly in step 1 (following the talking heads, the cocktail party stock picks, or the advisor without a process), then step 2, well . . . you better keep that motion sickness bag next to your letter opener.

Class is in Session

2008-11-13T08:28:00.000-05:00

I stumbled upon some some great explanations of recent events from martketplace.org (as in "Hi, I'm Kai Ryssdal and you're listening to Marketplace on NPR.)

They have a number of videos by Senior Editor Paddy Hirsch. The stick-figure-on-white-board lessons are great primers on what is going on. In the short (5 minute) videos he touches all sorts of terms acronyms you hear on a daily basis but might be a little (or a lot) fuzzy on such as: CDOs, naked shorting, CDSs, The TARP, margin calls. You can find them all here.

I think the most enlightening one is on CDOs (below):

Crisis explainer: Uncorking CDOs from Marketplace on Vimeo.

No good news?

2008-11-11T08:46:00.000-05:00

I was listening to Squawk Box while shaving this morning. I know better than to listen to CNBC while shaving, or anything, for that matter. Driving, shaving, or operating machinery while listening to CNBC is, in my opinion, about as dangerous as gets, dangerous as texting, reading email or blabbing away on your PDA while driving. I have been stupid enough to shave and listen to Squawk Box before; I've got a styptic pencil, too.

This morning was sort of different. After Ned Riley, of Riley Asset Management, said a few wise words (he’s as baffled as anybody is over why investors, who couldn’t get enough of Stock A at 21 times earnings yielding 2.5%% a year ago wouldn’t want to buy shares of Stock A by the truckloads, now that it’s down 50%, at 11 times earnings and yielding 6%). After Ned wrapped up his talk, Joe, Becky, and Carl (above) said they had scoured everywhere this morning, (everywhere to them was the Wall Street Journal, New York Times, USA Today, and Investors’ Business Daily) and couldn’t find anything good, anywhere.

Done with shaving and all the Squawk Box I could stand, I finished dressing, took the dogs out, and headed to my 7:00 am meeting. Justin and I were first on the agenda at a meeting of the board of directors of Gate City Rotary Club, to which I belong. To build up an endowment to provide capital to reinvest in the people, projects, and values we hold dear, we formed our own 501(c)(3) corporation. Although we've been buying investments for a little less than a year (a non-meaningful span, performance-wise), the board wanted a progress update. And so with the help of the Investment Committee, we did our best to explain why what we owned was in alignment with our value philosophy, and to say that our relative outperformance, in this period way to brief to be meaningful, was not due to any brilliance on our part, but to our slow to act style, plus a healthy dose of good luck. And while many investors, I am sure, watched and worried through the remainder of Squawk Box, wondering when this unrelenting, ravenous bear market would find a bottom, 11 Rotarians committed to service above self reflected on what 80 years of wealth creation looked like through all the wars, invasions, recessions, crises, and panics. One steps back, takes a deep breath, and feels a sense of gratitude upon realizing a value approach is inherently sound and that a long-term investment policy for maintaining and growing wealth will remain long after we're all gone. And despite Joe, Becky and Carl saying they couldn't find anything good this morning, we knew this was good.

When I got in to work, I overheard Anne saying she too had heard Joe, Becky and Carl on Squawk Box this morning report how they couldn’t find anything good anywhere.

And there it was, the first thing I saw, and in honor of Veteran’s Day, too, Service Dogs Give Hope, and Help to Wounded Veterans. Be sure to check out the slideshow.

Gratitude, the healthiest of human emotions, seems to have a way of finding whatever is good. Maybe that’s why good news is so scarce. If you know a Veteran, why don't you call or write them this week and tell them how grateful you are for them, and that you live in a free nation. And the next time someone says they can't find anything good anywhere, don't believe them.

. . . so, what are we doing?

2008-11-07T09:07:00.008-05:00

Justin here. This is from our most recent market commentary, (here):

One of our clients called, saying he had a question: “I’m just curious as to what you are doing to insure that I won’t lose a lifetime of savings?” . . . I’m going to take a cue from my old high school algebra teacher and assume that if someone in the class asks a question, chances are that other folks in the room are wondering the same thing.

In the commentary, we include an excerpt from Warren Buffett's 1987 letter to shareholders, which features his explanation of the way he thinks about the stock market - what he calls Mr. Market.

Buffet's words are so clear and helpful that is should be required reading before anyone opens a brokerage account (maybe I'll include that on my "suggestions box" form for President Elect Obama.)

As a side note, you can find all of our past commentaries here. If you'd like to be added to our quarterly mailing list, send me your mailing address and we'll be happy to send it to you the old fashioned way.

Inflation Hits the $1. 0 Cleaners

2008-10-31T11:15:00.004-04:00

Justin here. I have breakfast every Thursday with some guys over at Biscuitville. Across the street there is this Dry Cleaners shop that obviously didn't think through all the implications of inflation (pardon the poor picture; I snapped it with my phone.)

Not only is the new name on the sign $1.75 Cleaners, (note much bigger "7") but you can see on the window that they call themselves $1. 0 Cleaners, twice!

There is some equation in economics with a cute chart that dictates when you decide to raise prices (I think it's when Marginal Return equals Marginal Cost or MR=MC) . . . I think it should really read MR = MC + new signage.

Warren Buffett Op-Ed: Buy American. I Am.

2008-10-17T09:25:00.003-04:00

Justin here.

Warren Buffett wrote a great Op-Ed piece for the New York Times this morning. Well worth your next five minutes.

Buy American. I Am.

WARREN E. BUFFETT

Omaha

THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.

Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.

Warren E. Buffett is the chief executive of Berkshire Hathaway, a diversified holding company.

The Decabox

2008-10-14T13:46:00.011-04:00

Justin here.

We don't call market bottoms. It really isn't in our skill set and we wouldn't know where to start. We try to stick to buying cheap companies that we think will get less cheap.

But . . . if I was required by law to call the bottom, it would be when CNBC unveiled the decabox (left).

10 talking heads + 2 anchors + 3 scrolling tickers + 1 "is your money safe" logo = possible market bottom.

It looks like they unveiled it October 10th, see if you can find that day on this chart. But remember, we don't call market bottoms . . . unless required by law.

FIX IT!

2008-10-13T16:20:00.005-04:00

Justin here. We still have a long way to go, but Mr. Market was ecstatic today for some reason. Maybe someone took SNL's advice and decided to "fix it!" . . . or then again, it was probably just supply and demand. Speaking of Mr. Market, you can find our Market Commentaries here; the "poor fellow" plays a lead role in our newest one.

2:30 pm on April 28, 2004, did you know where your SEC Commissioners were?

2008-10-09T18:00:00.000-04:00

Stephen Labaton, in an article he published October 3 in the New York Times, provides a close up look into one of the most arcane moments of 2008, so far. Labaton explains how an obscure Securities and Exchange Commission decision led to an out of control financial crisis. Read it, and you'll see why Senator John S. McCain, on the day he was quoted as saying, "If I were President of the United States, I would fire Christopher Cox today. (That's Mr. Cox, on the left, chairman of the Securities and Exchange Commission, and Roel C. Campos, on the right, at a House hearing in 2007. Mr. Campos was on the commission in 2004 when a decision was made to change the net capital rule for big investment banks. Mr. Cox appears to be listening out of both ears.) As recently as March 11, 2008, Chairman Cox has said, "We have a good deal of comfort about the capital cushions at these firms at the moment.” How do you like that? I've read Labaton's article, silently. I've read it, out loud. I've read it to anyone who will listen. And I ask the same question every time: how could Mr. Cox have been so wrong? Give it a read.

The editors of the Times, with whom I disagree often, published a 4 minute slideshow of the April 28, 2004 meeting (pay close attention to Item #2) between SEC Commissioners and the heads of JP Morgan, Lehman Brothers, Merrill Lynch, Bear Stearns, and Goldman Sachs, in a basement conference room at the office of the SEC. Reading the article and viewing the audio slideshow won't lower your blood pressure, but it will provide valuable insights that the talking heads haven't.

I'm interested in what you think about this. I invite you to use the "comments section" found beneath this post.

Days till we reach zero

2008-10-07T16:53:00.015-04:00

On more down days than I'd like to admit, my team mates have heard me say, "At this rate, we'll be down to zero in no time." Now they've started saying it before I can get the very words out of my mouth. It's "tap code" at JSCO for a bit of gallows humor that our team uses to puts things back in perspective, to put the train back on the track, to put the cart behind the horse. You get the point. As any fool who can push a stick in the dirt can tell you, it's not going to go to zero, even though we sometimes think it will.

Stock markets are behaving as if all the indexes will go to zero in less than a month, maybe sooner. No one knows the future, but I for one have a hard time believing that this very real, very serious financial crisis will play out by going to zero. The Dow Jones Industrial Average, a proxy for the market, has in fact experienced record of volatility and panic selling this high only three times since December 31, 1946, the end of World War II:

October 16, 2002, when the Dow Jones was 8,036.03
November 9, 1987, when the Dow Jones was 1,900.20
November 5, 1974, when the Dow Jones was 674.75

The summers of 1962, when the Dow Jones was 572, and 1970, when the Dow Jones was 874, experienced high but slightly lesser volatility and panic selling. The chart below shows the Dow Jones Industrials and our fear and volatility indexes from December 31, 1946 to the present. Click the chart to full size.

No one knows where and when all this panic will land. Some wonder if it ever will. It will. History records that extreme volatility and panic selling do not last indefinately. At some point, the invisible hand of Adam Smith kicks in and eliminates whatever shortage exists. Some would say his invisible hand has already been working off the shortage of buyers. Extreme volatility and panic selling provide wonderful opportunities to buy shares of excellent businesses at bargain prices. Today's headlines are rarely the same as what history's judgement is going to be.

If you haven't already seen it, study the wonderfully perceptive presentation by Weston Wellington of Dimensional Fund Advisors that Justin described in his post of October 2, part of which is below:

"Earlier this week, I came across a presentation by Weston Wellington with Dimensional Fund Advisors, called "Is It Different This Time?" Wellington reviews our nation's past and, in particular, the media's reaction during those time. He does a great job of bringing some perspective to a volatile time. (Justin said viewing it was guaranteed to lower blood pressure 20 points for every viewing. If current levels of volatility and panic don't ease up soon, I'll need to view it several times a day. I guess there could be lot worse things than reinforcing one's long-term perspective.

This is not a recommendation to buy or sell any security, market, or an endorsement of any investment philosophy, firm, or process. This is just a call to sit down, take a breath, and study history.

If we did more of the latter, I think we could get out of this

2008-10-03T08:55:00.003-04:00

Friday morning's broadcast about the Wachovia Takeover included two pearls of wisdom; I heard them as the interview ended and think it's safe to assume Marketplace listeners (and Renita Jablonski) might not have heard them. The interview is only 3 minutes long and well worth hearing/reading. Click the player's "play" button to play; hit "pause" button at 3:03 marker to stop.

Bonus: Chris Whalen notices tremendous people at Wachovia.

TEXT OF INTERVIEW

Renita Jablonski: Wells Fargo is buying Wachovia for just over $15 billion. That takes Citigroup and the Federal Deposit Insurance Corporation out of the picture. Citi was only looking to grab Wachovia's banking operations. The FDIC said it would step in to pick up any loan losses. Wells Fargo says this morning it will acquire all of Wachovia and that it doesn't need the government's help.

We're joined now by Chris Whalen, managing director of Institutional Risk Analytics. Chris, you've been watching these developments for awhile. What do you think of Wachovia now getting together with Wells?

Chris Whalen: I think they're a much better fit for one another. I also was really a little concerned about Citi, because you know, they have the most subprime consumer focus in their business model -- Citi's loss rate on loans, for example, tends to be twice the other large bank peers'. So I am not keen on seeing Citi buy anything right now.

Jablonski: And we should mention that Wells Fargo did play a little game of hard to get here because it had initially wooed Wachovia with a $20 billion figure, kind of pulled out of that -- that's when the Citigroup / FDIC thing started and then came back. What brought Wells back to this?

Whalen: Well I think the Wells Fargo folks ran the numbers and they decided that they needed to make a bid. If you look at Wells Fargo's perspective, they have a way of getting into the northeast, into the southeast, and that's a beautiful thing for them, cause they're now a national franchise. And once they deal with the asset quality problems, they have tremendous people at Wachovia that they can integrate into the Wells Fargo. And I think they couldn't say no -- they had to get in the game. And that's great news for all of us.

Jablonski: How important is the timing of this deal, coming down on this day of the House bailout vote? I guess this raises the question, is government intervention truly necessary right now?

Whalen: Well, not this intervention. I've been opposed to the House plan since day one, and the reason is we're fighting a battle that we should have fought six months ago in terms of liquidity, the accounting rules that started this mess. And really, the big picture here is we're going through a deflation. We're having asset values fall, a lack of a bid for many assets. We have to fix that and make leverage our friend again.

Jablonski: But I have to ask you this, I mean it seems the perception at least is that Wall Street is so much counting on this bailout at this point.

Whalen: Well, don't worry about Wall Street. Believe me, Wall Street will be there tomorrow. But we've got to stop looking at short-term market indicators as an indication of reality. I think we spend far too much time looking at the television set and far too little time talking to one another. And if we did more of the latter, I think we could get out of this.

Jablonski: Well, it was good talking to you. [read: Me give up watching TV network news and opinion shows? No way.]

Whalen: Thank you.

Jablonski: Chris Whalen of Institutional Risk Analytics.

Is It Different This Time?

2008-10-02T16:14:00.007-04:00

Justin here. The late Sir John Templeton (pictured here, right, 30 years ago with Jonathan) is known for saying that the four most expensive words in the investing language are "this time it's different."

[Jonathan was fortunate enough to work for Sir John. You can read more about their relationship in our last commentary, here]

Earlier this week, I came across a presentation by Weston Wellington with Dimensional Fund Advisors, called "Is It Different This Time?" He reviews our nation's past and, in particular, the media's reaction during those time. He does a great job of bringing some perspective to a volatile time.

So what's in it for you? It is guaranteed to lower your blood pressure 20 points for every viewing.

It's well worth your next 15 minutes (or if you're really pressed, skip ahead to the "TIME 1970" slide and watch from there.)

The long and short is this: Life is rarely as bad (or as good) as it seems. Try your best to be patient, calm and rational.

"Well, I'm just a bill . . .

2008-10-01T09:02:00.004-04:00

. . . just a lonely old bill, and I'm sittin' here on capital hill. But now I'm off to the Senate where they sit and debate: adding a surtax to millionaires, an extension to unemployment pay, tax breaks for businesses and renewable energy, increasing FDIC insurance and adding a $1,000 tax credit for less affluent homeowners."

Justin here. I know that doesn't quite carry the same tune as the original Schoolhouse Rocks song, but this is a lot more complex than just "school buses must stop at railroad crossings" (no offense Bill).

The Doctor is In

2008-09-27T07:55:00.009-04:00

Ron Lieber knows value when he sees it. Not intrinsic value, but examination value. In his feature article in today's New York Times, he says good financial advisors have the examination skills of an ace psychologist. I've heard financial advisors called lots of things, but I haven't often heard them called keen observers of minds and money. Lieber rounded up a bunch of planners and advisors who got their starts as psychologists or studied the field as graduate students.

Lest you think I fall into either of those categories let me assure you neither I nor anyone else in my firm started as a psychologist nor studied psychology in graduate school. We have, however, spent hundreds of hours with psychologists, some spent on their couches trying to understand our own quirks and biases, but hundreds more spent with clients, psychologists, and psychiastrists on our couches, though fortunately not all at the same time. Meir Statman taught us how to "make science our ally". From Dan Ariely, we've discovered how hidden forces direct our minds in the making of decisions that are predictably irrational. CFA Institute provides us with a digital library filled with presentations on economics, finance, and behavioral psychology, explained by world-class experts in their fields.

We take our calling seriously and have asked more than one client to encounter professional therapy, and our reading room has served as a makeshift emergency room for more than one financial intervention, the most memorable of which included: the client couple, her therapist, his therapist, their accountant, our management team, and their small group. (I'm just glad the fire department didn't pop in that day, checking expiration dates on fire extinguishers and rounding up frayed extension cords, if they had, they would have had to join up with our recovery group (hey what's a few more people?), never mind leaving a fire truck parked on the curb with its flashers on. We look back on that day with fondness and gratitude; each participant shone, contributed magnificently, and on that day, the hero (the husband) and the heroine (the wife) put a stake in the ground, changed the river course for good, and re-wrote the history books of their lives.

Lieber's feature is worth the read. He shows real advisors in a light neither the newspapers nor the talking heads know anything about, maybe because it doesn't sell advertisements. Growing money is a process that doesn't happen overnight, it takes years and decades, not days. Check the article out here.

Most of you reading this post can take comfort in the reality that time on your side is the best insurance policy against volatility and permanent loss of capital. Some of you can't, maybe time isn't on you side. No psychology sheepskins here, just authentic, wise, and caring people, alumni of the bear markets, the emergency room, and the trenches of real life.

If anybody knows of any other articles about financial advisors serving as financial therapists, please leave leave a comment or drop us a line.

Economics Haikus

2008-09-26T15:11:00.001-04:00

Justin here. One of the blogs I have set up in my Google Reader is Freakonomics at the New York Times. They follow all the cardinal rules of blogging: short, funny, plenty of pictures, frequent but not too frequent posts.

A few weeks ago they asked readers to submit entries into an economic haiku contest (9th grade english refresher: poem with 3 lines each containing 5, 7, and 5 syllables in each respective line.) They had over 300 entries, but see the final six here.

I submitted the following haiku in honor of Jon's (his name at work) aka my Dad's (name on the weekend) 58th birthday today:

My Dad's Lesson to Me:

Speed, Price, Quality
You can get one, maybe two
But never all three.

— Posted by Justin

If my poem doesn't make sense, don't feel too bad; it's only because "Speed Price or Quality" wasn't said to you at least once per day as a kid. Like sitting at a slow gas pump because they are selling it for $0.05 and all the pumps are being used. Or when a fast (yet expensive) car would zoom by us on the road. Or when our pizza (fast and inexpensive) was delivered only partially cooked.

I carried on the tradition. Millie has always shopped at Wal-Mart, and when she comes home after waiting in the checkout line for 45 minutes, she says "Speed, Price or Quality" through her teeth. That was, of course, until the quality started to go south, and she decided it wasn't worth it to just get "Price". So she started shopping at Harris Teeter where she gained speed and quality, yet gave up price. And then she started clipping coupons, thus giving up speed and gaining back some price . . . and on and on the endless pursuit of all three.

Fascinating how that works.

The closest product I've found that has all three is Pastabilities, a restaurant in Greensboro with the best bread and pasta in town, fast service, wonderful ambiance, and a dinner for two with tip is under $20. Of course, usually when you find all three, prices go up, so get it while you can!

Presidential Address

2008-09-25T16:22:00.005-04:00

Justin here. I tuned in last night to watch the President address the nation about our financial crisis. I was impressed with the way he laid out the problem and its causes, clarified the difference between a "bailout" and an "investment", and explored the consequences of not doing anything.

He didn't say anything funny as in the past (like "Americans are working hard to put food on their families") but it was a great address none the less.

For anyone wanting a recap, it's well worth your next 12 minutes. Take caution though: The "If We Don't Do This" Scenario isn't for the faint of heart!

--Update #1--

It looks like we've done it after all. The video is still worth it

--Update #2--

. . . or maybe we haven't done it. (And note that the link under "Update #1" used to take you to an article that said "negotiations resolved; deal is on the way" or something like that.)

Enemies in the financial markets are fierce warriors

2008-09-18T17:18:00.004-04:00

Jonathan here. Having just talked with his friend in Manhattan, Dick Barron, business reporter at the Greensboro-News Record, writes, in his BizBytes newsletter (click here, follow instructions to subscribe to BizBytes)

"As one of my friends in Manhattan wrote today on [his] Twitter [page]: "Just walked to Wall Street for a meeting and back. The mood on the street is weird. Everyone looks weak, frightened and angry, like on 9/11" [emphasis mine].

Sun Tzu wrote The Art of War in the 6th century BC. His military strategies are still being taught.

“Draw them in with the prospect of gain. Take them by confusion. Use anger to throw them into disarray."

Understanding Sun Tzu's brilliant strategies puts the unprecedented economic events and (investors' unprecedented reactions) into perspective.

Investors have been drawn in with the prospect of gain.
Investors have been taken by confusion.
Investors have been thrown into disarray.

You need allies in your war. When the News-Record called us during Monday's 504 point drop in the Dow, we said investors needed to "take a deep breath," and we explained why we didn't need to "stay glued to the TV for the latest headline." Click here to read the article.

Predictably Irrational Group on LinkedIn

2008-09-15T07:45:00.001-04:00

I've been fascinated with LinkedIn since April, when an Internet search for my friend Mark Tosczak directed my web browser to his public profile on LinkedIn. (LinkedIn's reference to Mark appeared first in Google's search results page.

In July, after learning Linkedin had a dozen or so members (out of more than 20 million members) with keywords "Dan Ariely" or "Predictable Irrational", I launched the Predictably Irrational group on LinkedIn. LinkedIn recently enhanced Group functionality by providing our own page for group discussions, etc. Still in its infancy, I anticipate our discussions will generate unusual and stimulating insights. If you're interested in knowing more, click here.

Our group is diverse; vocationally, we represent, among other things:

Consultant in the U.K.

Quantitative analyst with Bank of America
Consultant with United Airlines
Director of Product Development with LinkedIn
Retired CMDR U.S. Navy
Another quant with Bank of America
Sales effectiveness coach in Paris
Resident at the Center for Future Banking
Professor with Duke University, the author
Scientist at LinkedIn
Health and Disability Speaker
Director of Security and Special Ops
Software Architect with Bluestreak
Principal Product Manager with eBay
Senior Training Specialist for USDA
Lead Business Analyst with Ocwen

The New Wonder Drug

2008-08-26T14:22:00.007-04:00

Justin here. What if I told you there was a drug that was written up in the New England Journal of Medicine in 2006 that saved 1,500 lives and $175 million in just 18 months in the ICU's of five hospitals in Detroit (that's 200 lives and $23 million per hospital per year)?

. . . and that the drug didn't have to be developed by big pharma or tested by the FDA or even have its ads run during sporting events (you know, the ads where a bunch of women are sitting around at a restaurant explaining, as happily as they can, that "headache, diarrhea, nausea, and back pain are all common side effects" of the new drug they're on)?

. . . and that the total (one time) cost to provide this drug for all ICU units in the United States was only $2 million but that it was only being used in Michigan, New Jersey, and Rhode Island?

. . . and that this wasn't even a "drug" at all . . . that it was a checklist.

There was a great article published in The New Yorker last December that I have summarized and highlighted below. You can find the complete version here.

This article is fascinating on so many fronts: it makes you think about your job and how it could be improved by the use of lists, it makes you think about the set-up of American medicine's dependence on drugs and sales, and it makes you consider the role of 'self' and your ability to be humble enough to realize that you don't know everything and/or can't store every bit of useful information in your head.

Enjoy . . . and sorry for the long article, but I think it's worth it.

The Checklist

If something so simple can transform intensive care, what else can it do?

by Atul Gawande December 10, 2007

If a new drug were as effective at saving lives as Peter Pronovost’s checklist, there would be a nationwide marketing campaign urging doctors to use it.

[ . . . ]

On any given day in the United States, some ninety thousand people are in intensive care. Over a year, an estimated five million Americans will be, and over a normal lifetime nearly all of us will come to know the glassed bay of an I.C.U. from the inside. Wide swaths of medicine now depend on the lifesupport systems that I.C.U.s provide: care for premature infants; victims of trauma, strokes, and heart attacks; patients who have had surgery on their brain, heart, lungs, or major blood vessels. Critical care has become an increasingly large portion of what hospitals do. Fifty years ago, I.C.U.s barely existed. Today, in my hospital, a hundred and fifty-five of our almost seven hundred patients are, as I write this, in intensive care. The average stay of an I.C.U. patient is four days, and the survival rate is eighty-six per cent. Going into an I.C.U., being put on a mechanical ventilator, having tubes and wires run into and out of you, is not a sentence of death. But the days will be the most precarious of your life.

A decade ago, Israeli scientists published a study in which engineers observed patient care in I.C.U.s for twenty-four-hour stretches. They found that the average patient required a hundred and seventy-eight individual actions per day, ranging from administering a drug to suctioning the lungs, and every one of them posed risks. Remarkably, the nurses and doctors were observed to make an error in just one per cent of these actions—but that still amounted to an average of two errors a day with every patient. Intensive care succeeds only when we hold the odds of doing harm low enough for the odds of doing good to prevail. This is hard. There are dangers simply in lying unconscious in bed for a few days. Muscles atrophy. Bones lose mass. Pressure ulcers form. Veins begin to clot off. You have to stretch and exercise patients’ flaccid limbs daily to avoid contractures, give subcutaneous injections of blood thinners at least twice a day, turn patients in bed every few hours, bathe them and change their sheets without knocking out a tube or a line, brush their teeth twice a day to avoid pneumonia from bacterial buildup in their mouths. Add a ventilator, dialysis, and open wounds to care for, and the difficulties only accumulate.

[ . . . ]

This is the reality of intensive care: at any point, we are as apt to harm as we are to heal. Line infections are so common that they are considered a routine complication. I.C.U.s put five million lines into patients each year, and national statistics show that, after ten days, four per cent of those lines become infected. Line infections occur in eighty thousand people a year in the United States, and are fatal between five and twenty-eight per cent of the time, depending on how sick one is at the start. Those who survive line infections spend on average a week longer in intensive care. And this is just one of many risks. After ten days with a urinary catheter, four per cent of American I.C.U. patients develop a bladder infection. After ten days on a ventilator, six per cent develop bacterial pneumonia, resulting in death forty to fifty-five per cent of the time. All in all, about half of I.C.U. patients end up experiencing a serious complication, and, once a complication occurs, the chances of survival drop sharply.

[ . . . ]

Here, then, is the puzzle of I.C.U. care: you have a desperately sick patient, and in order to have a chance of saving him you have to make sure that a hundred and seventy-eight daily tasks are done right—despite some monitor’s alarm going off for God knows what reason, despite the patient in the next bed crashing, despite a nurse poking his head around the curtain to ask whether someone could help “get this lady’s chest open.” So how do you actually manage all this complexity? The solution that the medical profession has favored is specialization.

[ … ]

We now live in the era of the super-specialist—of clinicians who have taken the time to practice at one narrow thing until they can do it better than anyone who hasn’t. Super-specialists have two advantages over ordinary specialists: greater knowledge of the details that matter and an ability to handle the complexities of the job. There are degrees of complexity, though, and intensive-care medicine has grown so far beyond ordinary complexity that avoiding daily mistakes is proving impossible even for our super-specialists. The I.C.U., with its spectacular successes and frequent failures, therefore poses a distinctive challenge: what do you do when expertise is not enough?

On October 30, 1935, at Wright Air Field in Dayton, Ohio, the U.S. Army Air Corps held a flight competition for airplane manufacturers vying to build its next-generation long-range bomber. It wasn’t supposed to be much of a competition. In early evaluations, the Boeing Corporation’s gleaming aluminum-alloy Model 299 had trounced the designs of Martin and Douglas. Boeing’s plane could carry five times as many bombs as the Army had requested; it could fly faster than previous bombers, and almost twice as far. A Seattle newspaperman who had glimpsed the plane called it the “flying fortress,” and the name stuck. The flight “competition,” according to the military historian Phillip Meilinger, was regarded as a mere formality. The Army planned to order at least sixty-five of the aircraft.

A small crowd of Army brass and manufacturing executives watched as the Model 299 test plane taxied onto the runway. It was sleek and impressive, with a hundred-and-three-foot wingspan and four engines jutting out from the wings, rather than the usual two. The plane roared down the tarmac, lifted off smoothly, and climbed sharply to three hundred feet. Then it stalled, turned on one wing, and crashed in a fiery explosion. Two of the five crew members died, including the pilot, Major Ployer P. Hill.

An investigation revealed that nothing mechanical had gone wrong. The crash had been due to “pilot error,” the report said. Substantially more complex than previous aircraft, the new plane required the pilot to attend to the four engines, a retractable landing gear, new wing flaps, electric trim tabs that needed adjustment to maintain control at different airspeeds, and constant-speed propellers whose pitch had to be regulated with hydraulic controls, among other features. While doing all this, Hill had forgotten to release a new locking mechanism on the elevator and rudder controls. The Boeing model was deemed, as a newspaper put it, “too much airplane for one man to fly.” The Army Air Corps declared Douglas’s smaller design the winner. Boeing nearly went bankrupt.

Still, the Army purchased a few aircraft from Boeing as test planes, and some insiders remained convinced that the aircraft was flyable. So a group of test pilots got together and considered what to do.

They could have required Model 299 pilots to undergo more training. But it was hard to imagine having more experience and expertise than Major Hill, who had been the U.S. Army Air Corps’ chief of flight testing. Instead, they came up with an ingeniously simple approach: they created a pilot’s checklist, with step-by-step checks for takeoff, flight, landing, and taxiing. Its mere existence indicated how far aeronautics had advanced. In the early years of flight, getting an aircraft into the air might have been nerve-racking, but it was hardly complex. Using a checklist for takeoff would no more have occurred to a pilot than to a driver backing a car out of the garage. But this new plane was too complicated to be left to the memory of any pilot, however expert.

With the checklist in hand, the pilots went on to fly the Model 299 a total of 1.8 million miles without one accident. The Army ultimately ordered almost thirteen thousand of the aircraft, which it dubbed the B-17. And, because flying the behemoth was now possible, the Army gained a decisive air advantage in the Second World War which enabled its devastating bombing campaign across Nazi Germany.

Medicine today has entered its B-17 phase. Substantial parts of what hospitals do—most notably, intensive care—are now too complex for clinicians to carry them out reliably from memory alone. I.C.U. life support has become too much medicine for one person to fly.

Yet it’s far from obvious that something as simple as a checklist could be of much help in medical care. Sick people are phenomenally more various than airplanes. A study of forty-one thousand trauma patients—just trauma patients—found that they had 1,224 different injury-related diagnoses in 32,261 unique combinations for teams to attend to. That’s like having 32,261 kinds of airplane to land. Mapping out the proper steps for each is not possible, and physicians have been skeptical that a piece of paper with a bunch of little boxes would improve matters much.

In 2001, though, a critical-care specialist at Johns Hopkins Hospital named Peter Pronovost decided to give it a try. He didn’t attempt to make the checklist cover everything; he designed it to tackle just one problem, the one that nearly killed Anthony DeFilippo: line infections. On a sheet of plain paper, he plotted out the steps to take in order to avoid infections when putting a line in. Doctors are supposed to (1) wash their hands with soap, (2) clean the patient’s skin with chlorhexidine antiseptic, (3) put sterile drapes over the entire patient, (4) wear a sterile mask, hat, gown, and gloves, and (5) put a sterile dressing over the catheter site once the line is in. Check, check, check, check, check. These steps are no-brainers; they have been known and taught for years. So it seemed silly to make a checklist just for them. Still, Pronovost asked the nurses in his I.C.U. to observe the doctors for a month as they put lines into patients, and record how often they completed each step. In more than a third of patients, they skipped at least one.

The next month, he and his team persuaded the hospital administration to authorize nurses to stop doctors if they saw them skipping a step on the checklist; nurses were also to ask them each day whether any lines ought to be removed, so as not to leave them in longer than necessary. This was revolutionary. Nurses have always had their ways of nudging a doctor into doing the right thing, ranging from the gentle reminder (“Um, did you forget to put on your mask, doctor?”) to more forceful methods (I’ve had a nurse bodycheck me when she thought I hadn’t put enough drapes on a patient). But many nurses aren’t sure whether this is their place, or whether a given step is worth a confrontation. (Does it really matter whether a patient’s legs are draped for a line going into the chest?) The new rule made it clear: if doctors didn’t follow every step on the checklist, the nurses would have backup from the administration to intervene.

Pronovost and his colleagues monitored what happened for a year afterward. The results were so dramatic that they weren’t sure whether to believe them: the ten-day line-infection rate went from eleven per cent to zero. So they followed patients for fifteen more months. Only two line infections occurred during the entire period. They calculated that, in this one hospital, the checklist had prevented forty-three infections and eight deaths, and saved two million dollars in costs.

Pronovost recruited some more colleagues, and they made some more checklists. One aimed to insure that nurses observe patients for pain at least once every four hours and provide timely pain medication. This reduced the likelihood of a patient’s experiencing untreated pain from forty-one per cent to three per cent. They tested a checklist for patients on mechanical ventilation, making sure that, for instance, the head of each patient’s bed was propped up at least thirty degrees so that oral secretions couldn’t go into the windpipe, and antacid medication was given to prevent stomach ulcers. The proportion of patients who didn’t receive the recommended care dropped from seventy per cent to four per cent; the occurrence of pneumonias fell by a quarter; and twenty-one fewer patients died than in the previous year. The researchers found that simply having the doctors and nurses in the I.C.U. make their own checklists for what they thought should be done each day improved the consistency of care to the point that, within a few weeks, the average length of patient stay in intensive care dropped by half.

The checklists provided two main benefits, Pronovost observed. First, they helped with memory recall, especially with mundane matters that are easily overlooked in patients undergoing more drastic events. (When you’re worrying about what treatment to give a woman who won’t stop seizing, it’s hard to remember to make sure that the head of her bed is in the right position.) A second effect was to make explicit the minimum, expected steps in complex processes. Pronovost was surprised to discover how often even experienced personnel failed to grasp the importance of certain precautions. In a survey of I.C.U. staff taken before introducing the ventilator checklists, he found that half hadn’t realized that there was evidence strongly supporting giving ventilated patients antacid medication. Checklists established a higher standard of baseline performance.

These are, of course, ridiculously primitive insights. Pronovost is routinely described by colleagues as “brilliant,” “inspiring,” a “genius.” He has an M.D. and a Ph.D. in public health from Johns Hopkins, and is trained in emergency medicine, anesthesiology, and critical-care medicine. But, really, does it take all that to figure out what house movers, wedding planners, and tax accountants figured out ages ago?

[ . . . ]

After the checklist results, the idea Pronovost truly believed in was that checklists could save enormous numbers of lives. He took his findings on the road, showing his checklists to doctors, nurses, insurers, employers—anyone who would listen. He spoke in an average of seven cities a month while continuing to work full time in Johns Hopkins’s I.C.U.s. But this time he found few takers.

There were various reasons. Some physicians were offended by the suggestion that they needed checklists. Others had legitimate doubts about Pronovost’s evidence. So far, he’d shown only that checklists worked in one hospital, Johns Hopkins, where the I.C.U.s have money, plenty of staff, and Peter Pronovost walking the hallways to make sure that the checklists are being used properly. How about in the real world—where I.C.U. nurses and doctors are in short supply, pressed for time, overwhelmed with patients, and hardly receptive to the idea of filling out yet another piece of paper?

In 2003, however, the Michigan Health and Hospital Association asked Pronovost to try out three of his checklists in Michigan’s I.C.U.s. It would be a huge undertaking. Not only would he have to get the state’s hospitals to use the checklists; he would also have to measure whether doing so made a genuine difference. But at last Pronovost had a chance to establish whether his checklist idea really worked.

This past summer, I visited Sinai-Grace Hospital, in inner-city Detroit, and saw what Pronovost was up against. Occupying a campus of red brick buildings amid abandoned houses, check-cashing stores, and wig shops on the city’s West Side, just south of 8 Mile Road, Sinai-Grace is a classic urban hospital. It has eight hundred physicians, seven hundred nurses, and two thousand other medical personnel to care for a population with the lowest median income of any city in the country. More than a quarter of a million residents are uninsured; three hundred thousand are on state assistance. That has meant chronic financial problems. Sinai-Grace is not the most cash-strapped hospital in the city—that would be Detroit Receiving Hospital, where a fifth of the patients have no means of payment. But between 2000 and 2003 Sinai-Grace and eight other Detroit hospitals were forced to cut a third of their staff, and the state had to come forward with a fifty-million-dollar bailout to avert their bankruptcy.

Sinai-Grace has five I.C.U.s for adult patients and one for infants. Hassan Makki, the director of intensive care, told me what it was like there in 2004, when Pronovost and the hospital association started a series of mailings and conference calls with hospitals to introduce checklists for central lines and ventilator patients. “Morale was low,” he said. “We had lost lots of staff, and the nurses who remained weren’t sure if they were staying.” Many doctors were thinking about leaving, too. Meanwhile, the teams faced an even heavier workload because of new rules limiting how long the residents could work at a stretch. Now Pronovost was telling them to find the time to fill out some daily checklists?

Tom Piskorowski, one of the I.C.U. physicians, told me his reaction: “Forget the paperwork. Take care of the patient.”

I accompanied a team on 7 A.M. rounds through one of the surgical I.C.U.s. It had eleven patients. Four had gunshot wounds (one had been shot in the chest; one had been shot through the bowel, kidney, and liver; two had been shot through the neck, and left quadriplegic). Five patients had cerebral hemorrhaging (three were seventy-nine years and older and had been injured falling down stairs; one was a middle-aged man whose skull and left temporal lobe had been damaged by an assault with a blunt weapon; and one was a worker who had become paralyzed from the neck down after falling twenty-five feet off a ladder onto his head). There was a cancer patient recovering from surgery to remove part of his lung, and a patient who had had surgery to repair a cerebral aneurysm.

The doctors and nurses on rounds tried to proceed methodically from one room to the next but were constantly interrupted: a patient they thought they’d stabilized began hemorrhaging again; another who had been taken off the ventilator developed trouble breathing and had to be put back on the machine. It was hard to imagine that they could get their heads far enough above the daily tide of disasters to worry about the minutiae on some checklist.

Yet there they were, I discovered, filling out those pages. Mostly, it was the nurses who kept things in order. Each morning, a senior nurse walked through the unit, clipboard in hand, making sure that every patient on a ventilator had the bed propped at the right angle, and had been given the right medicines and the right tests. Whenever doctors put in a central line, a nurse made sure that the central-line checklist had been filled out and placed in the patient’s chart. Looking back through their files, I found that they had been doing this faithfully for more than three years.

Pronovost had been canny when he started. In his first conversations with hospital administrators, he didn’t order them to use the checklists. Instead, he asked them simply to gather data on their own infection rates. In early 2004, they found, the infection rates for I.C.U. patients in Michigan hospitals were higher than the national average, and in some hospitals dramatically so. Sinai-Grace experienced more line infections than seventy-five per cent of American hospitals. Meanwhile, Blue Cross Blue Shield of Michigan agreed to give hospitals small bonus payments for participating in Pronovost’s program. A checklist suddenly seemed an easy and logical thing to try.

In what became known as the Keystone Initiative, each hospital assigned a project manager to roll out the checklists and participate in a twice-monthly conference call with Pronovost for trouble-shooting. Pronovost also insisted that each participating hospital assign to each unit a senior hospital executive, who would visit the unit at least once a month, hear people’s complaints, and help them solve problems.

The executives were reluctant. They normally lived in meetings worrying about strategy and budgets. They weren’t used to venturing into patient territory and didn’t feel that they belonged there. In some places, they encountered hostility. But their involvement proved crucial. In the first month, according to Christine Goeschel, at the time the Keystone Initiative’s director, the executives discovered that the chlorhexidine soap, shown to reduce line infections, was available in fewer than a third of the I.C.U.s. This was a problem only an executive could solve. Within weeks, every I.C.U. in Michigan had a supply of the soap. Teams also complained to the hospital officials that the checklist required that patients be fully covered with a sterile drape when lines were being put in, but full-size barrier drapes were often unavailable. So the officials made sure that the drapes were stocked. Then they persuaded Arrow International, one of the largest manufacturers of central lines, to produce a new central-line kit that had both the drape and chlorhexidine in it.

In December, 2006, the Keystone Initiative published its findings in a landmark article in The New England Journal of Medicine. Within the first three months of the project, the infection rate in Michigan’s I.C.U.s decreased by sixty-six per cent. The typical I.C.U.—including the ones at Sinai-Grace Hospital—cut its quarterly infection rate to zero. Michigan’s infection rates fell so low that its average I.C.U. outperformed ninety per cent of I.C.U.s nationwide. In the Keystone Initiative’s first eighteen months, the hospitals saved an estimated hundred and seventy-five million dollars in costs and more than fifteen hundred lives. The successes have been sustained for almost four years—all because of a stupid little checklist.

Pronovost’s results have not been ignored. He has since had requests to help Rhode Island, New Jersey, and the country of Spain do what Michigan did. Back in the Wolverine State, he and the Keystone Initiative have begun testing half a dozen additional checklists to improve care for I.C.U. patients. He has also been asked to develop a program for surgery patients. It has all become more than he and his small group of researchers can keep up with.

But consider: there are hundreds, perhaps thousands, of things doctors do that are at least as dangerous and prone to human failure as putting central lines into I.C.U. patients. It’s true of cardiac care, stroke treatment, H.I.V. treatment, and surgery of all kinds. It’s also true of diagnosis, whether one is trying to identify cancer or infection or a heart attack. All have steps that are worth putting on a checklist and testing in routine care. The question—still unanswered—is whether medical culture will embrace the opportunity.

Tom Wolfe’s “The Right Stuff” tells the story of our first astronauts, and charts the demise of the maverick, Chuck Yeager test-pilot culture of the nineteen-fifties. It was a culture defined by how unbelievably dangerous the job was. Test pilots strapped themselves into machines of barely controlled power and complexity, and a quarter of them were killed on the job. The pilots had to have focus, daring, wits, and an ability to improvise—the right stuff. But as knowledge of how to control the risks of flying accumulated—as checklists and flight simulators became more prevalent and sophisticated—the danger diminished, values of safety and conscientiousness prevailed, and the rock-star status of the test pilots was gone.

Something like this is going on in medicine. We have the means to make some of the most complex and dangerous work we do—in surgery, emergency care, and I.C.U. medicine—more effective than we ever thought possible. But the prospect pushes against the traditional culture of medicine, with its central belief that in situations of high risk and complexity what you want is a kind of expert audacity—the right stuff, again. Checklists and standard operating procedures feel like exactly the opposite, and that’s what rankles many people.

It’s ludicrous, though, to suppose that checklists are going to do away with the need for courage, wits, and improvisation. The body is too intricate and individual for that: good medicine will not be able to dispense with expert audacity. Yet it should also be ready to accept the virtues of regimentation.

The still limited response to Pronovost’s work may be easy to explain, but it is hard to justify. If someone found a new drug that could wipe out infections with anything remotely like the effectiveness of Pronovost’s lists, there would be television ads with Robert Jarvik extolling its virtues, detail men offering free lunches to get doctors to make it part of their practice, government programs to research it, and competitors jumping in to make a newer, better version. That’s what happened when manufacturers marketed central-line catheters coated with silver or other antimicrobials; they cost a third more, and reduced infections only slightly—and hospitals have spent tens of millions of dollars on them. But, with the checklist, what we have is Peter Pronovost trying to see if maybe, in the next year or two, hospitals in Rhode Island and New Jersey will give his idea a try.

Pronovost remains, in a way, an odd bird in medical research. He does not have the multimillion-dollar grants that his colleagues in bench science have. He has no swarm of doctoral students and lab animals. He’s focussed on work that is not normally considered a significant contribution in academic medicine. As a result, few other researchers are venturing to extend his achievements. Yet his work has already saved more lives than that of any laboratory scientist in the past decade.

I called Pronovost recently at Johns Hopkins, where he was on duty in an I.C.U. I asked him how long it would be before the average doctor or nurse is as apt to have a checklist in hand as a stethoscope (which, unlike checklists, has never been proved to make a difference to patient care).

“At the current rate, it will never happen,” he said, as monitors beeped in the background. “The fundamental problem with the quality of American medicine is that we’ve failed to view delivery of health care as a science. The tasks of medical science fall into three buckets. One is understanding disease biology. One is finding effective therapies. And one is insuring those therapies are delivered effectively. That third bucket has been almost totally ignored by research funders, government, and academia. It’s viewed as the art of medicine. That’s a mistake, a huge mistake. And from a taxpayer’s perspective it’s outrageous.” We have a thirty-billion-dollar-a-year National Institutes of Health, he pointed out, which has been a remarkable powerhouse of discovery. But we have no billion-dollar National Institute of Health Care Delivery studying how best to incorporate those discoveries into daily practice.

I asked him how much it would cost for him to do for the whole country what he did for Michigan. About two million dollars, he said, maybe three, mostly for the technical work of signing up hospitals to participate state by state and coördinating a database to track the results. He’s already devised a plan to do it in all of Spain for less.

“We could get I.C.U. checklists in use throughout the United States within two years, if the country wanted it,” he said.

So far, it seems, we don’t. The United States could have been the first to adopt medical checklists nationwide, but, instead, Spain will beat us. “I at least hope we’re not the last,” Pronovost said.

[ . . . ]

♦

"Mamas, don't let your babies grow up to be doctors . . . "

2008-08-14T10:05:00.009-04:00

Justin here. I found this nugget today in a Financial Planning article on serving clients in the medical field.

" . . . a recent survey of 3,016 physicians by healthcare consulting firm Merritt, Hawkins & Associates found that roughly 40% of doctors would not choose to enter the medical profession if they were deciding on a career again, up from less than 15% two decades ago. An even larger percentage would actively steer their children away from the medical field as a possible career choice."

If any of these doctors want to get out while they still can, author Frederick Buechner gives some great advice on finding the right vocation in Wishful Thinking, A Seeker's ABC.

Vocation - It comes from the Latin vocare, to call, and means the work a person is called to by God.

. . . By and large a good rule for finding out is this: the kind of work [you should do] is the kind of work (a) that you need most to do and (b) that the world most needs to have done. If you really get a kick out of your work, you've presumably met requirement (a), but if your work is writing cigarette ads, the chances are you've missed requirement (b). On the other hand, if your work is being a doctor in a leper colony, you have probably met requirement (b), but if most of the time you're bored or depressed by it, the chances are you have not only bypassed (a), but probably aren't helping your patients much either.

[Your vocation should be] the place where your deep gladness and the world's deep hunger meet.

My translation: "It's more than money."

Fighting ShortTermism

2008-08-05T14:30:00.001-04:00

Here's a great little piece from the WSJ today, Don't Give Up on That Fund - Not Yet.

. . . the study, conducted by Baird Advisory Services Research, looked at more than 1,300 funds, defining "high performers" as those that topped their benchmark by one percentage point annually over the 10 years ended in 2007. About 505 funds qualified.
The key finding was that many of these top funds went through periods where they got killed by the market or their peer group. More than three-quarters of these high achievers had at least one three-year stretch where the fund lagged behind its benchmark by one percentage point or more. More than half of the funds experienced benchmark underperformance of three percentage points or more, and nearly one-third of them lagged behind by five percentage points or more in a three-year period.

Despite those bouts of underperformance, the funds were able to be superior achievers over the full 10-year window.

Tim Byrne, director of Baird's Private Wealth Management Research, Products and Services, said the moral of the study is that even the best money managers have periods where they don't look so good, but the longer an investor sticks with them the better the chances for success, for high performance over time.

"The problem is that people buy a fund after the manager has proven that they are a high performer, but they sell the first time there's a problem," Mr. Byrne said. "They wind up chasing performance -- buying high and selling low -- instead of sticking with a manager who has proven that they can deliver if you give them enough time."

Mr. Market goes alligator watching

2008-08-04T22:53:00.014-04:00

A quick check on AAII’s sentiment survey reading for July 31 showed bullish sentiment rose to 40%, from 35.8% on July 24 and bearish sentiment fell to 41% from 44%. Not surprising, our Anxiety Index went down. Just two weeks ago, bullish sentiment was a lot less and bearish sentiment was a lot more than average. Can a normal investor make sense of this sudden shift?

Well, Mr. Market is not a normal investor but he surely is helpful. For instance, on a recent tour boat trip down the Florida Everglades, Mr. Market heard a thrashing sound in the waters. Curious fellow that he is, he got up from his seat and ambled over to the railing. The sight of a 3,000 point alligator (aka meat grinder) sniffing around for dinner got Mr. Market all worked up, which happens every so often. He got so excited and made such a fuss that all the other passengers jumped out of their seats and hurried over to the other side to see what all the excitement was about.

Now, let's think for a minute. Hearing all the hubbub and seeing 100 passengers going to the other side of the boat and leaning over the railing to get a good look at whatever it was that Mr. Market was enthralled over, would you grab your digital camera and say to your spouse, "Honey, I'm gonna get me a picture of that alligator if that’s the last thing I do!"

Or would you keep your seat and your cool, ignore the crowd, and locate the nearest life preserver storage box and lifeboat?

Click this not-so-exciting chart to open a larger not-so-exciting chart -

The greatest story never told

2008-07-23T23:40:00.001-04:00

The center stages of the world are crowded - "Just a short time ago, says Patrick J. O'Hare of Briefing.com, "there was a fear of owning financial stocks. Now there is a fear of not owning them." These are times when whatever good numbers get published or whatever progress we make towards correcting the policies and practices that led to our excesses and the mess we’re now in, the markets could care less.

Patrick Toomey is president of The Club for Growth. A graduate of Harvard University with a degree in government, he served as a member of the U.S. House of Representatives from Pennsylvania’s 15th Congressional district from 1999-2005. In 2005, he co-founded Team Capital Bank, and is co-chair of its board of directors. He also sits on the boards of directors of the Lynde and Harry Bradley Foundation and the Commonwealth Foundation. Recently, Toomey spoke at Hillsdale College. He says we need to start telling this story, and also to think about its causes. An introduction follows -

“The fact of the matter is that we in the United States, and to a lesser degree the entire world, have just lived through---and continue to live in---the greatest period of prosperity in human history. Over the last 25 years, more wealth has been created, more people have been lifted out of poverty, standards of living have been elevated more dramatically, and the quality and length of life have improved, more than ever before in recorded history. Unfortunately, as Larry Kudlow says, this is "the greatest story never told." Click here the read Toomy's speech.

Market sentiment and anxiety 07172008

2008-07-21T16:35:00.004-04:00

The AAII sentiment survey (membership required) measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market short term; individuals are polled from the AAII Web site on a weekly basis. Only one vote per member is accepted in each weekly voting period.

For the week ending July 16, bullish sentiment rose to 25.00% from 22.17%, equal to 1.29 standard deviations below the mean. Bearish sentiment rose to 58.14%, equal to 2.9 standard deviations above the mean. Anxiety Index rose from -11.9% to -8.8%, equal to 0.47 standard deviations below the mean. Click chart to resize.

Market sentiment and anxiety 07102008

2008-07-13T14:03:00.011-04:00

Sentiment data is displayed along with a proprietary anxiety index. The chart above includes something that the AAII version doesn’t. Click chart to resize.

At every date along the X Axis of this chart, you can see what the S&P500 did one year out from that date. For example, if you put your finger on the X axis on October 19, 1990, for example, and then moved your finger up to where the S&P500 intersects with that date, you’ll see that the S&P500, in the 12 months following, was up 26%. During the last 21 years there have been 14 or so occurrences where negative sentiment outweighed positive sentiment, and by a pretty big margin. (Resize chart by clicking and dragging handles.)

Couldn't help noticing Tuesday David Tice agreed to sell his David W. Tice & Associates investment management firm to Federated Investors Inc. for up to $142.5 million. Is this this pure coincidence or did Tice decide bearish sentiment was high enough (and bullish sentiment low enough) to sell out? Tice, who founded the Prudent Bear and Global Income Fund in 1995, will remain with Federated Investors. The purchase price, if certain conditions are met, could be 8.53% of assets under management. Is that a record? Guess Tice knows how to run a Bear fund, and a thing or two besides.

Short-termism

2008-07-11T13:02:00.019-04:00

The chart (click to enlarge) shows annual turnover rate (churn rate) for shares of NYSE listed companies. The black axis (Y1) shows annual turnover increasing dramatically from 10 to 30 percent during 1940 to 1980. During 1998 to 2008, turnover increased from 76 to 139 percent. Time held (years) is shown on the red axis (Y2); each NYSE share was "held" continuously by an investor four to eight years, presumably before it was sold, during 1940 to 1980. In the last ten years, this "holding period" has been punctuated from sixteen months to down to less than 9 months.

Such a churn rate imparts higher transaction costs to investors; with greater trading also comes the risk of making greater mistakes.
An investment requiring 2 - 3 years time for the market to recognize potential increases in intrinsic value faces unprecedented opposition, in an environment that typically keeps its shares less than nine months before selling to buy another.
Corporate managements, under ever increasing pressure from stockholders, financial analysts, global competitors, and takeover groups sacrifice long-term strategic vision in the pursuit of beating "next quarter's earnings guidance."
In contrast, a group of Fortune most admired corporations for "long-term investment" had an average turnover rate of close to 60 percent in 2005.

Short-termism destroys wealth. CFA® Institute occupies the forefront in a vital challenge to raise awareness and to challenge the wide range of short-termism's stakeholders to exercise leadership in the effort to win a war against the unnecessary destruction of capital. CFA® Institute's excellent resources may be accessed here.

source: NYSE Factbook, Forbes, CFA® Institute, Jonathan Smith & Co.

Did someone say Trillion dollar deficit?

2008-07-09T07:05:00.001-04:00

Bill Gross, by many accounts, is one of the wisest persons on the planet, at least when it comes to fixed income investing. His perspectives and explanations about plain old Main Street Economics are worth knowing; I recommend adding him to your Reader.

Gross prefaces his July 2008 Investment Outlook with this…

“Thought I would jot down this little note to President Obama. It’s a little presumptive of course; first that he’ll even be President (he will) and second that he’d read it (he won’t). But presumptiveness is an inherent requirement of an investment manager and so I shall proceed.”

If the prospect of a one Trillion Dollar Deficit by the year 2011 makes you just a little curious as to how something like that could really happen, take the next five minutes and read Bill Gross’ letter to Senator Barack Obama.

History may not repeat itself, but it does rhyme. Take a look at what happened to another nation when their deficit grew out of hand to nearly 11% of their GDP.

The Golden Toilet

2008-07-08T08:59:00.017-04:00

Justin here. Meir Statman once said that rational investors are investors who “always prefer more wealth to less and are indifferent as to whether a given increment to their wealth takes the form of cash payments or an increase in the market value of their holdings of shares.”

I don't know when we started misquoting him, but in our office we are constantly reminding each other that "rational investors are not concerned with the timing or form of wealth."

For example, a rational investor would be indifferent to $50 won on a lottery ticket, $50 in a Christmas card, $50 from the Home Depot returns desk, or $50 from a paycheck. I don't know about you, but for whatever reason, I spend the Christmas and Home Depot dollars very differently.

I thought about Professor Statman as I read this article in the Wall Street Journal about Lam Sai-wing, a Hong Kong entrepreneur who built his fortune around a golden toilet.

Mr. Lam owned a jewelry manufacturing company and was contemplating how to turn it into a successful retail venture. His idea to make a golden toilet (when gold was $200/ounce) eventually snowballed into a golden palace that, at its height, attracted 100 tourist groups per day and did $100 million in sales annually.

Mr. Lam seemed to be doing the rational thing when gold hit its peak at $1,003.20 - he started selling off the palace bit by bit. See if you can find where the rational turns to irrational.

He is melting down golden chandeliers, armchairs and armored knights and selling gold by the ton to fuel growth plans that include hundreds of new retail outlets in mainland China. But even with the selloff, one thing is certain: the toilet stays.

"I don't care if gold hits $10,000 an ounce," Mr. Lam says. "I'm not melting it down."

Interesting. He'll sell everything else at a gain somewhere under 200% but won't sell the toilet, even if it goes up 4,900% or roughly 10x the historic peak! Talk about flushing money down the toilet.

"I don't need all that extra gas mileage"

2008-06-30T16:17:00.002-04:00

Justin here. When I was in high school I had a 1977 International Harvester Scout II, it was the ultimate guys truck: removable top, loud speakers, big wheels, three horns . . . the works. As anyone who wanted to could, I'm able to track my life stages in cars (and miles per gallon). It goes something like this:

Impending College Travel - Sell Scout (~12mpg) and buy 1999 Chevy Tahoe (~15mpg)
Married My Lovely Wife - Inherit and drive her 1992 Honda Accord (~24mpg)
My Wife Starts Commuting 100 miles per day - Sell '92 Accord (~24mpg) for '00 model (~23mpg)
Baby On The Way - Sell 2 door Tahoe (~15mpg) for 4 door Toyota 4Runner (~19mpg)
My Quarter-Life Crisis - Sell Honda Accord (~23mpg) and buy 1991 Toyota Landcruiser (~14mpg)

So my rationale on that last one went something like this: "Due to our low key social lives and my 1.2 mile commute to work, I only drive 4,000 miles/year in this Accord. I change my oil once a year for goodness sakes! It would only cost me $20/dollars per month to drive a car that I love. I really don't need all that extra gas mileage." That last sentence was an actual quote. Al Gore would be ashamed.

I read this article in the NYTimes about 'gas tourism' in Mexico. Folks travel to the border, wait in line, go to the nearest gas station, wait in line, go back to the border, wait in line, and go home. One guy does that trip all day long to fill up a fleet of trucks. One guy even visited an orthodontist and got cheaper braces while south of the border. One guy has been mugged at gunpoint, yet still goes back!

I don't really have that option where I live, so I'm walking home for lunch, taking the more fuel efficient car when able, even borrowing my Mom's volvo station wagon (with embarrassingly feminine 'pet named' vanity license plate) for long trips.

Come to think of it, I might rather be held up at gun point than have one more trucker ask me at the gas pump how her vanity plate acquired the name 'Bunn1e.'

The prediction markets

2008-06-29T22:39:00.007-04:00

Summarized from Jeff Matthews, who is not making this up -

"On Monday, everyone will be watching our fundraising totals to see if we can compete with the McCain campaign. This month is the first test of our grassroots fundraising strategy since we declared our independence from the broken campaign finance system....Make a donation of $30 or more by midnight on Monday, June 30th, and show off your support with an Obama logo T-shirt...Obama Raises $22 Million in May, His Weakest Month This Year Associated Press June 20, 2008 10:23 p.m.

"WASHINGTON -- Democrat Barack Obama raised $22 million in May for his presidential campaign, his weakest fund-raising month this year, and ended the month with $43 million cash on hand, the campaign reported Friday. In Wall Street's parlance, the Obama campaign "missed the number" in the month of May. Sure, $22 million in one month is a lot of money, even in Presidential politics. But the Obama campaign's earnings 'momentum' slowed sharply in May: that $22 million was down 29% sequentially from the $31 million raised in April. Well, Intrade has buyers willing to pay 65.3 for the right to earn 100 if Obama wins the election. Not to mention the Swift-Boaters that have turned their sites from Hillary to Obama: Michael Bloomberg actually had to publicly deny that Obama is secretly a Muslim. There's one more reason we'd bet Obama won't stay at 65.3 for very long: he's the front-runner now, and America likes front-runners to earn their place. So, while we never recommend stocks in these pages, if Obama was a stock, we'd short him right here.

Everyday heroes

2008-06-12T14:18:00.012-04:00

Gate City Rotary is taking fund raising to the next, next level. They’ve gone and gotten a bunch of sponsors, rented out the ballpark, hired Sleeping Booty Band, sold raffle tickets, put poster ads in every restaurant, and done a few radio interviews.

JSCO is a sponsor, but yours truly hasn't sold any tickets yet, per se, but I have the best of intentions. I had thought about blogging our poster with a handful of pics of the raffle prize, a fully restored 1976 Triumph TR6, which I would love to drive up and down Sunset Hills, to and from work, and everywhere else. The other night, I even said to Anne “hey, what about hitching up Georgia and River and putting some ice and beer in the Radio Flyer wagon and going door-to-door, down Ridgeway Drive and Madison Avenue, and sell this great party and the charities it will fund?” We could set up the boom box on top. I could almost hear the Isley Brothers singing Caravan of Love. Well, one excuse is as good as another, so they say, so let’s just say the road to you know where is paved with good intentions.

So it was a surprise joy to learn today that my friend and neighbor Beth Sheffield has already surpassed Gate City Rotary in promoting the event in Sunset Hills, and beyond. Beth found out about the fundraiser, not from me, but because she already knew Father Marc and supports his orphanage. I know it's just a matter of holding the winning ticket when that number gets called, but it sure would be awesome if Beth and her husband Gardner won the TR6. (Gardener, you may recall, joined a group of Gate City Rotarians last December to help kids in the Glenwood Tutoring Program make and hoist Lighted Christmas Balls down at Grace Community Church.) I can’t think of a better couple to win the Triumph. Who knows, they might even offer guided tours in the TR6, top down, heater on, Sleeping Booty on the boom box, Lighted Christmas Balls glowing...

The Value of Leader$hip

2008-05-14T11:02:00.010-04:00

Nancy Opiela’s article in the May-June 2008 CFA Magazine asks, "Is behavioral transparency more telling than financial transparency?"

E. Ted Prince, (featured in Opiela’s article) the founder and CEO of Perth Leadership Institute (be sure to check out his new white paper, The Financial Psychology of the Presidential Front Runners and Its Impact on U.S. Competitiveness), knows a lot about behavioral finance and a thing or two besides. To quote Prince,

"We’ve trained analysts to look at financial matrices, not at human behavior. To use an analogy, we’re making investment decisions using the 10 percent of matter we can see in the universe. There’s still that 90 percent of dark matter that’s hidden from view that doesn’t factor into anyone’s decisions...each individual has a systematic but unconscious bias on all decisions which have financial impacts and ramifications...if we can identify that bias, we can predict not only the financial decisions the executives might make but the impact of those decisions on overall financial performance and profitability and ultimately determine the financial value and market valuation of the companies they run."

Drawing on years of experience, Prince developed assessment tools to classify individuals by their financial “signature," which is what essentially drives different ‘decision styles’ into three buckets: balanced, resource-centric, and value-centric.

Prince, who believes, "The more financial signatures you have that are value-centric, the better you'll do in terms of your valuation relative to your peers...so you can think of the financial styles as having a direct impact on your profitability relative to your competitive peers," is on to something.

Now I don't know what my "financial signature" is, but I won’t be surprised if we have at least two value-centric signatures sitting on this Investment Committee, even on the days when I don't attend. Like the words musician Michael Lee Aday (aka Meat Loaf) sung in his second single hit, “’Cause two out of three ain’t bad.”

Investment Process and predictable cognitave errors

2008-05-14T08:07:00.009-04:00

I meet with two colleagues each Wednesday. We needed a name for our committee, back when we started meeting and so we named it the Investment Committee (portfolio performance is our business imperative). Each person brings a unique something to the table. Most committees don't seem to benefit from the “sum of the parts” axiom, which, in most other spheres, theorizes that the sum of the parts is worth more than the whole. This committee is different. (You may recall my sailboat experiment. So far I've sold the mast, bow pulpit, and the trailer. The kick-up rudder is, at this moment, on Craigslist. But I digress.

We don't tell each other what we want to hear. Dissent is actually encouraged. We get to ‘go to school’ on each other’s mistakes. My ‘school,’ at 32 years, is the longest running, including 12 years as a stock broker (where I learned from Sir John Templeton, that outperforming the majority of investors requires doing what they are not doing, and to buy when pessimism is at its maximum) and 20 years as Registered Investment Advisor. Brian, our Senior Portfolio Manager, has 14 years’ worth. Justin has 3 (but they’re in dog years). He’s actually studied for the CFA Institute’s Chartered Financial Analyst designation) the last three years while putting his money where his mouth is. He knows mistakes are just an inevitable part of the investment process, “if we don't make too many bad mistakes, we'll do just fine,” he says. Now there’s a man who understands the wisdom of Yogi Berra.

I’m not sure what I did to deserve the privilege of working with not one but two highly calibrated decision makers, who focus constantly on knowing the 60/40 end of any investment proposition; not only do they know the 60 end of the stick from the 40 end, they operate with integrity whether the chips are up or down.

Cognitive errors are predictable, this we know, and they fall chiefly into four buckets: a) investor overconfidence, b) loss aversion, c) narrow framing, and d) overweighting samples of short term data. We’re every bit as capable of making the cognitive errors as the clients we serve, but the difference is, we’re trained to not act on those errors.

Glenwood Tutoring Program

2008-05-13T11:57:00.002-04:00

Here's something big,
Worth believing in,
Worth investing in...

Two marathons in one day

2008-05-02T13:29:00.009-04:00

Friend and fellow Gate City Rotarian Darlene Leonard sent this article from the News-Record. When I saw Run Bobby Run! in the subject line I didn't have to wonder what she sent me.

I'm not a runner, but running marathons and doing my job (aka managing the hopes, dreams, fears, savings for college and retirement, for 117 wonderful client families) have a lot in common. Bobby, for those who might not now, is a runner. He runs through my neighborhood all the time. As much as he runs, he probably runs through everyone's neighborhood all the time.

Turns out, "When you're running you face challenges every day, but you have to keep on going, and when you get through it, there's a sense of accomplishment. So running is a metaphor for how we live every day -- for life, I guess." Says Bobby Christiansen, 50, marathon runner and Gate City Rotarian.

Bobby, I learned, runs with another runner in my neighborhood, Daniel Hassell, 40, dad, husband, physician, and friend; Daniel's too humble to say this about himself so I guess I'll have to say it for him: Daniel has without a doubt one of the best Lighted Christmas Ball displays in all of Greensboro, and that says a lot because he's across the street from me!

By the way, Bobby and Daniel ran in the Boston Marathon this Monday (check out their times), so if you happen to be posted where you can cheer them as they run by (and hopefully take pictures), don't blink or you're likely to miss them.

optimism is dangerous - stack the odds in your favor.

2008-04-27T22:25:00.009-04:00

see another graph that's quite possibly the most creative thing ever done with Windows 98 and XP sounds.

Making a difference

2008-04-16T15:21:00.015-04:00

The News-Record's Sonja Elmquist wrote a wonderful article about 600 orphan children living in one of the world's poorest nations, and how two men stepped up to the plate ten years ago to make a difference.

Brothers in law Jack Reynolds and Father Marc share a vision: make a sustainable difference in the lives of Haiti's orphans. All this excitement takes place at Theo's Work. Jack raises the money and encourages Father Mark in his role. Jack is really good at inviting anyone who will take him seriously to go with him to Haiti to see and to do, first-hand, meaningful life-changing work. Father Marc runs the orphanage and school and encourages Jack in his role. Father Marc does a terrific job involving and thanking donors, something not easily accomplished in the world of non-profits.

So far, Jack's involved at least three guys I know in this important work: Max Kern, Chuck Downey, and Drew Jones. Max, Chuck, Jack and I (and about 55 other fired-up men and women) are Gate City Rotarians. I don't know if Drew is a Rotarian or not, but he doesn't stand a chance. Next time he jogs through Sunset Hills, Jack and I plan to tackle him and bring him to a Thursday morning meeting, which if you haven't attended, you should.

Whoever said Rotary is just a club for old men and their fathers hasn't visited Gate City yet. I've been places where I've read the vision statement but at Gate City, I feel the vision statement.

All you need to know about halos and investment performance

2008-04-09T13:51:00.008-04:00

Read "Affect in a Behavioral Asset-Pricing Model" in the Financial Analysts Journal by Meir Statman, Kenneth L. Fisher, and Anginer. I don't know Fisher or Anginer, but I know Statman knows his stuff. You'll need a login/pw to read the full text on CFA Publications or read selected portions from the abstract/summary below:

"We outline a behavioral asset-pricing model in which expected returns are high when objective risk is high and also when subjective risk is high. Investors prefer stocks with positive affect, and their preference boosts the prices of such stocks and depresses their subsequent returns. The preferences of investors were gathered from surveys conducted by Fortune magazine in 1983--2006 and in additional surveys we conducted in 2007. From the Fortune data, the authors found that the returns of admired stocks, those highly rated by the Fortune respondents, were lower than the returns of spurned stocks, those rated low. This finding is consistent with the hypothesis that stocks with negative affect have high subjective risk and their extra returns compensate for that risk. In these surveys, we presented investors with only the names of companies and their industries and asked them to rate the affect of these companies. The questionnaire said, "Look at the name of the company and its industry and quickly rate the feeling associated with it on a scale ranging from bad to good. We found a positive correlation between these affect scores and the companies' Fortune scores. Moreover, we found that positive affect creates a halo over stocks that results in perceptions that they promise high future returns coupled with low risk." FAJ, March/April 2008, Vol. 64, No. 2: 20-29

Tails that wag dogs and other behavioral traps

2008-04-08T18:09:00.010-04:00

Friends Jim Ware, CFA and Jamie Zeigler, CFA, co-authors of High Performing Investment Teams: How to Achieve Best Practices of Top Firms, and founders of Focus Consulting Group of Long Grove, IL, say this about their work with investment firms:

"concentrating on understanding and improving behavioral forces at work within the firm and trying to help its financial leaders understand and leverage the firm's culture to achieve a competitive advantage is essential. Avoiding many of the behavioral finance mistakes requires a culture that is self-aware. Managers have to get better at asking themselves, 'What am I doing right now, and why and am I doing it? If I'm selling a stock, what's my real motivation? Are my actions based on a gut feeling or thorough research?'

Michael Ervolini, Founder and CEO of Boston Based Cabot Research, says,

"as an industry, we've talked about behavioral finance for a decade, but until not, portfolio managers have not had a way to apply it. Now's the time to move behavioral finance from cocktail talk to an integrated part of one's investment discipline."

I say take it one step further.

My firm is an SEC registered investment advisor. We've mailed investment performance reports to clients for twenty years.

That’s eighty quarterly reports for the twenty year client, sixty reports for the fifteen year client, and so on and so on.

Before we know it, we've given our otherwise “normal” clients lots and lots of opportunities to draw unintended conclusions from the tail that wags the dog. This, in turn, causes no small numbers of otherwise well-meaning, intelligent people to make unwise financial decisions, for instance, selling out, foregoing further contributions to 401(k) plans, and saving $0.50 by leaving the cream cheese off when ordering a bagel.

I see opportunity.

Besides illustrating your asset allocation or estimating dividends for the coming year, were you truly informed the last time you looked at your broker’s statement? If performance soared or you beat your brother in law, did you feel smart? If seeing the cover of Money Magazine depressed you because they picked the best performing funds, in advance, and you didn't, will this emotional self-whipping help you navigate successfully over the next 50 years or maintain your purchasing power?

I’m passionate about overcoming unproductive behavioral forces, and highly motivated to reengineer this dog-wagging tail of a thing known as investment performance reports.

I'd love to hear ideas, opinions, and feedback.

And heed Jane Bryant Quinn's advice: give financial porn a wide berth.

View Dan Ariely: Predictably Irrational on FORA.tv (click Dan or the link below to launch)

2008-04-05T16:23:00.002-04:00

View Dan Ariely: Predictably Irrational on FORA.tv

Dan Ariely on Bear Stearns

2008-04-05T16:21:00.002-04:00

Did the lines between taking risk and cheating blur? You be the judge.

Predictably Irrational

2008-04-01T23:00:00.001-04:00

John Tierny published an article February 26, 2008 titled The Advantages of Closing a Few Doors. A devotee of Dan Ariely's informative discoveries about how humans make all sorts of decisions, most of which are hazardous to our financial, physical, and emotional health, Tierny lays out a careful explanation.

You don't need to be a Ph.D. to know humans have a love affair with our options, and there are no lengths we won't go to keep as many options open. It's when we see the doors closing on our options, as doors invariably do, we respond, not in rational ways, but in normal human, ways.

If you like keeping options open (I know I sure do) take the online test at Tierny Lab.

Further Reading: "Predictably Irrational: The Hidden Forces That Shape Our Decisions." Dan Ariely; HarperCollins, 2008.

"Keeping Doors Open: The Effect of Unavailability on Incentives to Keep Options Viable." Jiwoong Shin, Dan Ariely. Management Science, May 2004. (PDF)

What you need to know about tax stimulus payments

2008-02-26T13:32:00.006-05:00

Fellow Gate City Rotarian and helpful friend Darlene Leonard, C.P.A., of Smith Leonard, PLLC, shared this important heads up:

If you have elderly friends or relatives, let them know that they will need to file a tax return for 2007 in order to be eligible for the stimulus refund payment of $300 for individuals or $600 for a couple.

To be sure there are many elderly folks out there who do not file a return simply because they are only receiving social security benefits or have minimal income.

But they won’t get their stimulus refund payments unless they file a tax return. And unless someone like you tells them, they’re not likely to know, so here’s what you need to know:

If you normally don't have to file a tax return but have enough in qualifying income to receive a stimulus payment, more information is available in Fact Sheet 2008-16. If you qualify, all you need to do is fill out Form 1040A in a few places. A sample version of Form 1040A illustrates which lines to fill out. Click this link for a 2007 Form 1040-A (PDF) U.S. Individual Income Tax Return and click this link for instructions 2007 Inst 1040-A (PDF) Instructions. Pretty easy, huh?

Now hear this: The only guarantee I can make is that my Chief Compliance Officer will totally freak out if I do not make the following disclosure, so here goes:

Neither Jonathan Smith & Co. nor any of it’s employees (this writer included) is qualified to give tax advice, therefore nothing in or about this message, including any external internet links, shall be construed as tax advice, or for that matter, investment advice. If you need assistance, for goodness sakes, you should contact a qualified tax professional. Like the warning label on my father's chainsaw, Do Not Sharpen Saw While Motor Running, you could get hurt and you could hurt someone else if you don't know what you're doing.

Overvalued or Undervalued?

2008-02-22T13:53:00.005-05:00

The Power of Whimsy
By PHYLLIS KORKKI
Published: February 17, 2008

By one rough estimate, Sandra Boynton has sold around a half-billion cards, which may make her one of the best-selling card creators of all time.

Within the first four paragraphs these words leapt off the page:

“I don’t do things differently to be different; I do what works for me,” she says. “To me, the commodity that we consistently overvalue is money, and what we undervalue is our precious and irreplaceable time. Though, of course, to the extent that money can save you time or make it easier to accomplish things, it’s a wonderful thing.”

And once again, I was reminded why people keep coming to Jonathan Smith & Co. Click here to read the full story.

The Legacy of the 1936 Election

2008-02-20T22:55:00.002-05:00

Wonder why the candidates seem so confused? Amy Shlaes writes, "WHAT MAKES the current field of candidates so timid? It is clear listening to figures from both parties this year that they still believe Social Security is untouchable. This despite the fact that bringing Social Security into solvency is a relatively easy task. When it comes to the more serious fiscal burdens upon our grandchildren, the candidates are likewise timid. This despite the fact that those burdens only become heavier as we delay. We speak of 2008 as an election year, but it is also the year when the tide of Social Security cash begins to recede with the retirement of Baby Boomers. But where is the origin of the problem? Traditionally historians have focused on the slow rise of American progressivism over the past century and a half. I’m going to do something different, and undertake an almost artificial exercise. Here I will compress history and argue that this destructive hesitation comes out of a single political campaign, the presidential campaign of 1936. This campaign marked the virtual end of old-fashioned American federalism and the rise of a new kind of politics. It was 1936 more than any other campaign that created modern interest groups and taught us that Washington should subsidize them. Pinning blame on a single campaign (and its run up) may seem facile. Still, the story is well worth telling." Click Imprimis.

Imprimis

2008-01-24T10:08:00.000-05:00

This link takes you to The link takes you to a commentary entitled “Deregulation of the New Zealand Economy” about the Canadian economy vis-à-vis the US economy with a sidebar on socialized medicine. I suspect many of our clients and friends would find this publication very interesting. Imprimis

Elder-Care Costs Deplete Savings of a Generation

2007-02-12T14:52:00.000-05:00

December 30, 2006
Elder-Care Costs Deplete Savings of a Generation
By Jane Gross

To care for her ailing 97-year-old father over the past three years, Elizabeth Rodriguez, a vice president at the Federal Reserve Bank in New York, has borrowed against her 401(k) retirement plan, sold her house on Staten Island and depleted nearly 20 years of savings. Click here to read entire article.

"Courage doesn't roar, sometimes, courage is the quiet voice at the end of the day saying, 'I will try tomorrow"

2007-02-06T15:38:00.000-05:00

Jeri Rowe, of the News-Record, writes about courage, the kind of courage that's alive and well at Greensboro's Sanctuary House. It's a story about ordinary heroism that will warm your heart, renew your faith in humankind, and maybe make you want to invest in something bigger than yourself. It's about God delighting in the least of these, and those who partner with them in their journeys, and the sacredness of life, no matter how small or insignificant that life might seem. I am learning that the poor have so much to teach us.

Click Rowe: The helping hand of Bobby to read the column...be sure to see the photo collection.

"People love greatness, people love the story of his bravery," Dr. Dean Richardson, D.V.M.

2007-01-30T15:45:00.000-05:00

After 8 Months, Setback Ends Barbaro’s Battle
By JOE DRAPE
Published: January 30, 2007
The Kentucky Derby winner was euthanized, ending an extraordinary effort to save his life after a leg injury. Click to read the complete article.

“She has served the good Lord, she has served the church, she has served us. What better legacy can she leave?”

2007-01-30T09:06:00.001-05:00

In Connecticut, World’s Oldest Woman Dies at 114
By JENNIFER MEDINA
Published: January 30, 2007
Born to former slaves in North Carolina, Emma Faust Tillman briefly held the title of the oldest person in the world. Click to read full article.

Where's the willingness to embrace responsibility?

2007-01-20T19:28:00.000-05:00

Business / Your Money
For Top Executives, a Need to Be Aware of the Nearest Exit
By PHYLLIS KORKKI
Published: January 14, 2007
Being a chief executive has many perks, but job security is not one of them.

Are executive gluts one indication of cheap industries or industries where managements have displaced responsibility? If you have an opinion I'd like to know.

Delay Denied on Tax Accounting Rule

2007-01-14T19:48:00.000-05:00

Delay Denied on Tax Accounting Rule
By DOW JONES/ASSOCIATED PRESS
Published: January 18, 2007
The rule would have required companies to take a more stringent approach to reporting uncertain tax positions on their financial statements, and offers an expanded view of Gretchen Morgenson's January 14, 2007 article, A Tax Secret Emerges from the Murk.

Money operates above and below the waterline

2007-01-05T16:54:00.001-05:00

Money is just a tool, though probably the most adaptable tool ever known to man. But unlike tools, money operates both above and below “the waterline.”

Above the waterline, we exchange money, its most basic level, for food, clothing, shelter and the many other things we enjoy in life; education, health care, vacation, sports camps, and the myriad of other things we take for granted.

Below the waterline money operates at an emotional level. There, money has the potential to break relationships, ruin marriages, control children, provide a false sense of worth or power. It also has the potential to build a marriage, provide for the needs of others, start a business, build a school, reclaim a neighborhood, or drill a well, just so folks can have clean drinking water.

Ask almost any middle aged American male how much money he needs to retire. Most will tell you quickly and easily, even if they haven't prepared a financial plan. They know what they need to have, financially speaking, by the time they retire from work, to support them for the rest of their days. But somehow, and it almost always happens like this, when they get close to having "the number" something goes off inside, they step back, and shotput their "number" way down the field, off they go in search of a bigger number than the one they thought would work.

Why? I wish I knew. I'm sure there are many reasons, not the least of which is if you don't enjoy what you have now, how could you be happier with more?

And so on some level, discontentment with what we have causes us to believe more will lead us to better life.

Vocation

2007-01-01T16:33:00.000-05:00

Have you ever thought about the kind of work you do? Life is too short to work at something you don't enjoy, if you have a choice. Here's something I've found really helpful about vocation:

Frederich Buechner says Vocation – comes from the Latin vocare, to call, and means the work a person is called to by God. Buechner says there are all different kinds of voices calling you to all different kinds of work, and the problem is to find out which is the voice of God rather than Society, say, or the Superego, or Self-Interest. By and large a good rule for finding out is this: the kind of work God usually calls you to is the kind of work (a) that you need most to do and (b) that the world most needs to have done. If you really get a kick out of your work, you’ve presumably met requirement (a), but if your work is writing cigarette ads, the chances are you’ve missed requirement (b). On the other hand, if your work is being a doctor in a leper colony, you have probably met requirement (b), but if most of the time you’re bored or depressed by it, the chances are you have not only bypassed (a), but probably aren’t helping your patients much either. Neither the hair shirt nor the soft berth will do. The place God calls you to is the place where your deep gladness and the world’s deep hunger meet. From: Wishful Thinking, A Theological ABC, by Frederick Buechner

Worldmapper

2006-12-31T07:00:00.000-05:00

I came across an amazing webtool - Worldmapper, which as the site says, is a collection of world maps, where territories are re-sized on each map according to the subject of interest. Definately a must see.

I don't know

2006-12-28T13:12:00.000-05:00

"I don't know."

How many times have you heard that answer? Whether the question is, "Which colors do you like best, where do you want to go to dinner, or what do you want to do this weekend,” “I don’t know” sounds pretty much the same in any language.

Some questions, like the one the barista at Starbucks asks, "Leave room for cream?" you seem to answer effortlessly. Answers to other questions seem to get stuck in some perennial version of "I don't know."

Behavioral psychologist say our answers to life’s questions often have more to do with reasons that don’t relate to the question much less make any sense. Take our barista friend, for example. When she said, "Leave room for cream?” you said, “Yes,” never mind that you didn't want cream. You said “Yes,” because when you said "No," she filled your cup full and on your way to work, your coffee slopped out the plastic lid, down the double cup and all over the front of your nice clean starched shirt. That’s why you say “Yes.”

We went to work on implementing a financial plan for a wealthy family a few years back. We didn't do the planning, the CPA they used for years did. Upon determining that the family held too little money in equities and too much money in bonds, and after several meetings between the family and the CPA, we were brought in to see if we were all going to get along, you know, in the areas of investment philosophy, communication, style, and whether we were fans of the right ACC team. The accountant nodded his head, and we got the thumbs up. Great, we thought.

In meetings that followed, without the accountant, we probed deeper: “So," we said, "What do you want to do with your money?” The reply: “We don’t know, just make it grow.” Second try: “O.K., so what are your hopes and dreams for the future?” The reply: “Just keep on doing what we’ve been doing.” Third try: “So, how do you want to influence the future with your money?” You guessed it: “We don’t know.”

Want to know what happens when you do a financial plan and totally ignore your life meaning plan?

Stay tuned.

How Suite It Isn’t: A Dearth of Female Bosses

2006-12-20T14:50:00.000-05:00

By JULIE CRESWELL
Published: December 17, 2006
Though more women are getting M.B.A.’s, few reach the corner suite.

Our management team (and Beth Michaels) should find this interesting given Jonathan Smith & Co. has a woman in a senior management position.

Social Entrepreneurship

2006-04-27T11:41:00.000-04:00

Social Entrepreneurship? Listen to this podcast from Kelly Green of the Wall Street Journal if you've every thought about volunteering after retirement.

Love and Money

2006-03-28T23:02:00.000-05:00

Jeff Opdyke's article on Love and Money in this week's Your Money Matters column in the WSJ provides "tomorrow morning ready" insights into understanding and surviving a very touchy reality; the challenges of unequal income in a partnership, including what happens when the partner is the higher earner, and whether it's especially difficult when one spouse stays home with the kids. This 11:31 minute podcast is a must hear. Click to listen.